October 2020

Interest Rates

Short-term rates

Figure 1: Treasury bill yield and money market rates

Notes: AWCMR- Average Weighted Call Money Rate,
SDFR- Standing Deposit Facility Rate, SLFR- Standing
Lending Facility Rate, T-bill yields are for the secondary market, ARR – simple average of daily repo rates
Source: CBSL

The CBSL held the policy rates unchanged in October. Call rates, which are now downward immobile, were steady and continued to remain around 4.53% with modest volumes. On the other hand, thinner repo volumes continued to hold the rates ~6bps above the floor policy rate.

The GoSL paid down over USD 1 Bn maturing ISBs along with its final interest component on 2nd October which translate to about LKR 185 Bn drain on reserves from the money market. To nullify the effect, the CBSL bought over LKR 123 Bn T-bills (most likely through a private placement) and injected LKR 36 Bn via term reverse repos by 2nd. Nevertheless, the overnight liquidity, dropped by nearly LKR 48 Bn on 2nd but gradually started to rise thereafter. Liquidity level spiked to over LKR 210 Bn on 20th after the CBSL further increased its stock of T-bills to nearly LKR 502 Bn. Overnight liquidity fell markedly once again by over LKR 38 Bn on 29th likely as a result of another forex payment.

Call market activity surges whenever the overnight liquidity falls significantly below LKR 200 Bn as evident from recent market movements. ICRA Lanka previously suspected asymmetry in liquidity among the market participants to be prevalent. The CBSL’s liquidity injections through term reverse repo window may have helped to resolve this liquidity distortion. The CBSL has not used term repo window since June this year. They injected 115 Bn through the said facility so far since the beginning of the latest cycle on 28th September.

The first two auctions of the month saw T-bill yields continue to rise (6-10 bps) amid the drop in excess liquidity. Both these auctions were oversubscribed but partially filled. However, during the third auction held on 21st, a day before the Monetary Policy Committee (MPC) meeting, the yields dropped sharply (16-86 bps) in expectation of a rate cut. In the subsequent auction, the yields rose back to original levels after the CBSL held the rates unchanged. This auction was partially filled despite having being oversubscribed presumably to hold the rates down at the cut-off yields.

The performance of the secondary T-bill market was tepid. 6M and 12M yields fell marginally while bid-ask spreads eased. Market volumes were modest however, spiked on the day after the MPC meeting.

Long-term rates

Figure 2: Yield curve of treasuries

Notes: Yields are based on the weekly average prevailed at the last week of the month, Shorter end – less than 2Y, mid/intermediate tenor – 2 to 10Y, longer tenor – above 10Y, Source: CBSL

Secondary bond market performance was dull. Yields, most notably the mid-tenor securities, that swelled following the Moody’s two notch sovereign downgrade, corrected back to August levels while the bid-ask spreads narrowed as October wore on.

Figure 3: AWPR[1] and 3M T-bill yield

Note: T-bill yield for secondary market

Source: CBSL

AWPR, declined in October further narrowing the spread recording the lowest value YTD against 3M T-bill yield indicating continued improvement in risk appetite of banks. Influenced by the expectation of policy rate cut, in the third week, the AWPR declined sharply by nearly 80 bps but then started to retreat in later weeks.

Credit to private sector and the government expanded by LKR 87 Bn and LKR 199 Bn respectively in September. Reserve money expanded by nearly LKR 30 Bn during October. ICRA Lanka expects the private sector credit growth momentum to continue in October as well.

International rates

Figure 4: Month open international lending rates

Notes: The SOFR Averages are compounded averages of the SOFR over rolling 180-calendar day periods.

Source: New York Federal Reserve and global-rates.com

The performance of the US treasuries was mixed –  yields edging lower over the dimmed prospects of a coronavirus stimulus package, while having the opposite effect with better-than-expected US retail and unemployment data. Investors were also worried over rising COVID-19 cases in US and Europe. Additionally, as Biden’s lead over Trump widened in the run up to the election, investors turned bullish gravitating towards capital markets.

Both LIBOR USD and its’ replacement rate, SOFR, fell in October. LIBOR, which has a credit spread, remains above SOFR, a secured rate.

Moody’s sovereign downgrade continued to put pressure on the yields of the ISBs. Situation was further aggravates by the country succumbing to the second wave of coronavirus infections. Bonds with the nearest maturity (27-Jul-21) saw yields shoot up by ~2400 bps while longest maturity (28-Mar-30) bonds saw yields increasing by ~480 bps.

External Sector

Figure 5: Exchange rate and outstanding forward volume

Source: CBSL

In September, trade deficit widened to USD 525 Mn as imports climbed to USD 1.5 Bn while exports were flat around USD 1 Bn. Hindered by the coronavirus outbreak, the merchandise exports suffered a negative growth of 15% (Y/Y) to USD 832 Mn [1] in October mainly on account of 19% (Y/Y) contraction of apparel exports. Robust performance of remittances recorded 2.4% growth during the first 10 months of the year compared to the corresponding period of 2019 lifting it above the pre-crisis level.

LKR 8.4 Bn foreign capital, of which LKR 3.1 Bn (USD 17 Mn) from the treasuries and LKR 5.3 Bn (USD 29 Mn) from the equities have exited the country in October. Capital flight in the treasuries was triggered by the expected policy rate cut, while in equities it was the escalation of the coronavirus cases in the country.

Nearly USD 1.2 Bn foreign currency payments, including USD 1 Bn ISBs with interest, were settled during October, while USD 588 Mn is pending for the rest of the year. With milder pressure on the rupee, the CBSL was able to be a net buyer of foreign currency (USD 47.5 Mn) during the period. However, gross official reserves slid to USD 5.8 Bn.

Rupee was broadly stable against greenback. Early October LKR/USD appreciated to 184.2 as the liquidity dropped and later settled around 184.30 when it was normalized. Interbank forex market remained active in the first half of the month. As the economic uncertainty surrounding the resurgence of COVID cases mounted, the outstanding forward volume was seen expanding rapidly.

Figure 6: Gross official reserves (Mn USD)

Source: CBSL

Prices & Wages

Figure 7: CCPI and Nominal Wage Rate Index of the informal private sector (Y/Y)

Notes: WRI (100=2012), CCPI (100=2013)

Source: CBSL

Wage growth recovered and rose above inflation in September with continued recovery of the economy.

CCPI Headline inflation was flat at 4.0% (Y/Y) in October. Food inflation slipped to 10% (Y/Y) but was counterweighed by the rise in non-food inflation to 1.3% (Y/Y).

Equities

Domestic Market

Figure 8: ASPI (M/M)

Source: CSE

ASPI lost over 4%, while CSE’s liquid S&P lost over 7% as investors remained on the side line to get clarity on budget proposals and awaited 3Q corporate financials in October. Trading continued to be dominated by domestic retail investors while foreigner investors were on the sell-side. In this context, market PBV (Price-to-book value) declined to .96 from 1.

All GICS sectors recorded loses with the exception of transportation, materials, healthcare, and automobiles.

Figure 9: GICS sector performance- October

SectorIndex Points Gain
Transportation1104
Materials147
Healthcare Equipment & Services89
Automobiles & Components1
Utilities-15
Commercial & Professional Services-16
Consumer Services-16
Food & Staples Retailing-17
Retailing-26
Capital Goods-36
Telecommunication Services-41
Food, Beverage & Tobacco-51
Banks-54
Diversified Financials-57
Insurance-66
Energy-69
Household & Personal Products-75
Real Estate-77
Consumer Durables & Apparel-127

Source: CSE

Global Markets

US markets wobbled as the prospects of a US fiscal stimulus went through a rollercoaster ride after several false starts in October. Hopes of vaccine and a clear Biden victory kept the market upbeat. But towards the latter part of the month, as the corona infections soared to record numbers in US and Europe, investor spirit dried out. At the European front, likelihood of a hard Brexit sent shockwaves to European equities. Emerging market equities were mixed but notable gains were seen in Sensex (India), Jakarta Composite (Indonesia), and Merval (Argentina).

Commodities

Figure 10: Crude oil price

Source: Bloomberg quoted in CBSL

Uncertainty about US stimulus and Corona virus flare-ups in Europe weakened the global demand for crude oil.

Figure 11: Tea (All Elevations) price and quantity sold at weekly auctions

Source: Forbes & Walker

Tea prices continued to climb gradually in October but the production fell as labour deployment was interrupted by the coronavirus.

Figure 12: Coconut price and quantity sold at weekly auctions

Source: CDA

CDA suspended coconut auctions from 30th September indefinitely as coconut prices soared due to supply shock. Meanwhile, the government imposed a price cap on coconut in an attempt to control the prices.

Figure 13: Rubber price weekly auctions

Note: Price of Latex 4X

Source: RRISL

A rebound in auto production in China and increased demand for medical gloves have sent prices of rubber soaring, making it one of the best-performing commodities in the world in recent months [2].

Figure 14: Gold price

Source: CBSL

Gold price was mostly stable during October and failed to spark investor interest despite growing global economic uncertainty.

Figure 15: Base metal price index (2016=100)

Notes: includes Aluminum, Cobalt, Coper, Iron Ore, Lead, Molybdenum, Nickel, Tin, Uranium, and Zinc

Source: IMF

Base metal prices flattened out as China’s industrial demand remained the only major demand driver and concerns of another global slowdown with US and Europe engulfed in the second wave of coreona infections.

Real Sector

Figure 16: PMI deviation from point of neutrality (Index points)

Notes- negative values indicate sector is generally contracting on a month-on-month basis while positive values indicate the sector is expanding. The strength of contraction or expansion is manifested by the magnitude of the figure.

Source: CBSL

PMI data indicates the economy continued to recover for the 4th straight month in September. Manufacturing sector expansion was mainly on account of production, new orders, labour hiring, and input purchases. However, the supply channel disruptions were prevalent. Services sector expansion was still weak, but the sector saw new businesses and activities expanding while backlogs continued to clear. Employment also expanded in response to this. Despite all these positive developments, coronavirus resurgence weakened the outlook for business activities in the services sector.

ICRA Lanka’s nowcasting models show GDP contracted by 17.5% (margin of error = +/- 16%) in 2Q to and by 6.1% (margin of error = +/- 6%) in 3Q. Based on our predictive models we expect the economy to contract by 7.9 (base case) to 17.8% (protracted case) in 4Q.

Read ICRA Lanka’s 3Q Economic Update to see a complete list of predictions.

Outlook for November

With coronavirus cases surging daily, the economic activities will be impeded. Labour shortage either due to forced or self-imposed isolation will likely spread to many industries and businesses. These disruptions are already having their toll on the export oriented manufacturing industries and will hurt the reserve accumulation of the country. Headline inflation is likely to remain around 4%. In this background, we do not rule out the possibility of another monetary easing in the next (scheduled for 26th November) Monetary Policy Committee meeting.


[1] AWPR is calculated based on the submissions made by the commercial banks to the CBSL on the rates offered to customers who borrowed more than LKR 10 Mn for less than three months.


Disclaimer

This publication has been prepared by ICRA Lanka solely for information purposes without regard to any particular user's investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ICRA Lanka does not represent that it is accurate or complete. ICRA Lanka does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication.