September 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 call market rates remained steady about 2-3 bps above the floor policy rate while the repo rates displayed some volatility in September. Volumes were thin in the money markets however, picked up to some extent in the second half of the month as the overnight excess liquidity in the market dipped in the third week. The drop in liquidity was likely a result of the GoSL buying foreign currency to pay down external debt from the CBSL.

The CBSL bought over LKR 28 Bn T-bills from weekly auctions held on 16th and 23rd September, which were oversubscribed but only partially filled, possibly to hold the yields down amid a dip in market liquidity. In addition, to improve the liquidity, towards the end of the month, the CBSL injected LKR 30 Bn via term reverse repos. In addition, the bond issuance held on 11th September, which absorbed over LKR 86 Bn from the market, may have had a bearing on the market participants’ ability to bid in the immediate subsequent auctions. During the bond auction held on 28th September, only 44% of the initial offered amount was awarded. ICRA Lanka believes the liquidity levels are asymmetrically distributed among the market participants evidenced by the recent dynamics of the money market. Moreover, Moody’s two notch downgrade of Sri Lanka’s sovereign ratings to Caa1 on 28th September [1] intensified the pressure for yields to rise.

Secondary T-bill market had modest volumes. The spread between 3M and 12M T-bills rose as yields of 3M T-bills fell. The bid-ask spread largely remained steady for the most part of the month up until the Moody’s downgrade.

Reserve money expanded by over LKR 12 Bn during the month with a notable increase during the 3rd week as both currency in circulation and commercial bank deposits soared.

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 treasury market volumes were modest and the activity spiked in the third week, which is generally characteristic of the weeks with primary bond issuances. Bond yields, especially the mid-tenor securities, jumped 10-30 bps immediately while trading at wider bid-ask spreads after Moody’s downgrade. Yield curve was loosely anchored at the shorter-end and marginally steepened as a result.

Figure 3: Secondary market T-bill yields and AWPR

Source: CBSL

In September, AWPR, which represents short-term lending to highly creditworthy borrowers, continued to fall gradually (~40 bps) in the first three weeks before rising back 20 bps in the last week as the drop in liquidity in the money market transmitted to credit markets.

Private credit grew by LKR 78 Bn (5%, Y-o-Y) in August in comparison to July after contracting for three straight months while on the other hand, the credit to the government down by LKR 47 Bn (37%, Y-o-Y). Private credit was weakened in the months following the Easter Attacks last year and hence presents a lower base to calculate credit growth for corresponding periods this year. The CBSL extended the deadline of application for 4% Working Capital Loan Scheme until 30th September which would lead to over LKR 100 Bn credit under this scheme.

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

US treasuries, had a bumpy ride in the first half of September with several sloppy auctions from early on. Data on US and China economic recoveries drew attention from investors attracting them to risky assets such as stocks over safe-haven assets, driving the yields higher. Federal Reserve indicated its commitment to keep interest rates at current levels until inflation overshot 2% for a sustained period and the U.S. hit full employment. However, stocks retreated towards the month end over fears of another wave of COVID-19 infections across Europe, giving way for treasury yields to fall. In addition, treasuries gained momentum following worries that US economy is losing impetus.

LIBOR USD rate flattened out in September while its’ replacement rate, SOFR, continued to fall. LIBOR, which has a credit spread, remains above SOFR, a secured rate. SLDB floating rate notes are linked to LIBOR, which is expected to be phased out by end 2021. In September, Malaysia became the second country in the region to use SOFR in a derivative instrument [2].

The yields on the SLISBs edged up sharper by ~170 to 540 bps following the Moody’s downgrade which weighs down on country’s ability to raise foreign currency debt. Nevertheless, the impact on yields was tapered towards the longer-dated bonds, which indicates the investors expect Sri Lanka to experience difficulties in the short to medium term.

External Sector

Figure 5: Exchange rate and outstanding forward volume

Source: CBSL

Exports and remittances marked USD 947 (-8.3%, Y-o-Y) and Mn USD 664 Mn (28.2%, Y-o-Y) correspondingly in August. Import restrictions helped to keep the trade deficit in check. In September, exports bounced back surpassing USD 1 Bn (5.16%, Y-o-Y) with apparels and commercial crops leading, while Europe and US being the top markets.

Over LKR 1.2 Bn foreign capital flew back to G-secs on 2nd and 3rd weeks of September on the back of improved risk appetite of the investors due to optimistic US and China economic recovery which might have reduced the pressure on the rupee on the first half of the month. In contrast, foreign investors continued to exit from equities.

The GoSL was expected to pay down over USD 990 Mn of forex debt in September which may have been primarily financed via the CBSL reserves. FX intervention during the month resulted in the net purchases close to USD 55 Mn. Accordingly, the official reserves declined to USD 6.7 Bn. Close to USD 1.5 Bn foreign currency obligations are pending for October and November months, of which just over USD 1 Bn was already paid on 2nd October for maturing ISBs along with its final interest component. The GoSL canceled JICA funded phase 1 of the USD 1.25 Bn light rail project. JICA signed a concessionary loan agreement with the GoSL worth USD 284 Mn in March 2019 [3]. Given the challenging external position of the country, this forex flow could have bolstered the reserves of the country.

Rupee displayed volatility against greenback during September, nonetheless, mostly appreciated during the month end amidst weaker dollar and import restrictions. Interbank forex market remained liquid. Outstanding forward volume contracted gradually throughout the month amid shrinking imports and market expectations of a relatively stable rupee in the near term. The cabinet approved offering swaps to hedge forex risk on bonds from which the GoSL hopes to lure more foreign investors.

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-o-Y)

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

Wage growth slipped and continued to remain under inflation eroding the purchasing power of consumers.

CCPI Headline inflation slipped to 4.0% (Y-o-Y) in September driven by the mild non-food inflation which is under 1%. Food inflation declined but remains at double digits as the country is being struck by supply shock from unfavorable weather and import controls.

Equities

Domestic Market

Figure 8: ASPI (M-o-M)

Note: CSE was closed for the whole month of April
Source: CSE

Equity investors were upbeat in September and the record performance of ASPI lifted it back to the pre-crisis level fueled by the quest for higher return in a low interest rate environment. Nevertheless, the enthusiasm of domestic investors was not shared by the foreign investors, where foreigners sold down over LKR 10 Bn worth of stocks. Participation among domestic retail investors was high. Heavy buying tipped the valuations in favour of sellers as market PBV (Price-to-book value) rose to 1 from .90.

Nearly all sectors made gains. Shipping, logistics, and tyre industry shares saw the largest gains for the second straight month. Increasing economic activities fuelled buying interest for energy, utilities, retail and consumer products shares.

Figure 9: ASPI sector performance- September

Source: CSE
Global Markets

The optimism that prevailed early on in US stocks in September quickly faded towards the month end as the hopes about fiscal stimulus stalled in Washington. Europe markets weakened due to the second wave of COVID-19 infections that swept key economies. Emerging markets closed weaker with the exception of Kospi (Korea), Nikkei (Japan), and IPC All-Share (Mexico).

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 remained buoyant in September, however the quantity sold was on the decline.

Figure 12: Coconut price and quantity sold at weekly auctions

Source: CDA

Coconut production continued to be affected by the unfavourable weather thereby driving the prices higher in September.

Figure 13: Rubber price weekly auctions

Note: Price of Latex 4X
Source: RRISL

Rubber prices rally continued in September on the back of demand for protective equipment.

Figure 14: Gold price

Source: CBSL

Gold prices dived to a new low from August levels but corrected upwards towards the month end. Bullish stocks may have triggered gold sell-off but the bleak global economic outlook that prevailed by the month end attracted investors back to gold.

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 are gaining momentum with industries returning to normalcy. China’s official and Caixin manufacturing purchasing managers’ indices (PMI) were both above the 50 divide at 51.5 and 53 respectively in September – thereby showing manufacturing was expanding [4].

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

The overall expansion in the Manufacturing sector seemed to be slowing down as seen from the declining index values of the PMI. As per the August PMI figures, the industries were on a recruitment drive in expectation of better demand in the upcoming season. However, order book and the production activities decelerated notably. Supplier delivery times were lengthening due to disruption in logistics.

On the contrary, services sector PMI shows a gradual expansion in activity. As the new businesses and day-to-day operations improved in August, backlogs were clearing. Businesses were upbeat about the expectations of activity in the near term. However, the employment was still weak.

Figure 17: Daily power generation

Note: Generation from other SPPs (Mini Hydro and Biomass) is not included
Source: PUCSL

The activities in the industrial and services sector seemed to have flattened out and operating with a slack as seen from levelled demand for power in September.

Outlook for October

Recent string of infections related to Minuwangoda cluster and other pockets around the country has cast a long shadow over prospects of faster recovery. It also poses a bleaker outlook for industrial exports, which is the need of the hour to accumulate reserves and protect the value of the currency.

There are several reasons for the CBSL to consider a rate cut on 16th October; (1) prevailing pressure for treasury yields to rise time to time as the liquidity slips, (2) asymmetry in liquidity among the market participants, (3) money market rates no longer have the downward mobility as prevailing rates are virtually converged on the lower bound of the policy corridor, (4) already slowing momentum of the economy, and (5) likely economic burden from partial lockdowns that are underway.

Sri Lanka’s external financing will face significant headwinds with the Moody’s downgrade. Close to USD 500 Mn foreign currency obligation are pending for October and November. Media reported the GoSL is expecting to secure USD 700 Mn from China.

Rating Actions

Following rating actions were taken by ICRA Lanka during the month of September.

Visit https://www.icralanka.com/ratings/ to read the rating rationales.

IssuerIssueActionPrevious RatingCurrent Rating
JAT Holdings (Pvt) LtdIssuer RatingReaffirmed[SL]A+ Stable[SL]A+ Stable
Bank of CeylonIssuer RatingReaffirmed[SL]AAA Negative[SL]AAA Negative
Habib Bank Limited (Sri Lanka branch)Issuer RatingAssignedN/A[SL]A+
Lankem Ceylon PLCIssuer RatingWithdrawn[SL]DN/A
LCB Finance LimitedIssuer RatingReinstated[SL]B StableN/A
Hayleys PLCIssuer RatingRevised[SL]A+ Stable[SL]A+ Negative
Hayleys PLCSenior Unsecured Listed Redeemable Debenture programmes (LKR 3,527 Mn)Revised[SL]A+ Stable[SL]A+ Negative
Hayleys PLCSenior Unsecured Listed Redeemable Debenture programmes (LKR 3,000 Mn)Revised[SL]A+ Stable[SL]A+ Negative
Hayleys PLCSenior Unsecured Listed Redeemable Debenture programmes (LKR 2,000 Mn)Withdrawn[SL]A+ StableN/A
Hayleys PLCSenior Unsecured Listed Redeemable Debenture programmes (LKR 2,000 Mn)Withdrawn[SL]A+ StableN/A
Associated Motor Finance Company PLCIssuer RatingReaffirmed[SL]B+ Negative[SL]B+ Negative
Arpico Finance Company PLCIssuer RatingReaffirmed[SL]B+ Negative[SL]B+ Negative
Regional Development BankIssuer RatingRevised[SL]A Negative[SL]A- Negative
Regional Development BankSubordinated Unsecured Listed Redeemable Debenture programmes (LKR 2,000 Mn)Revised[SL]A- Negative[SL]BBB+ Negative
Regional Development BankSubordinated Unsecured Listed Redeemable Debenture programmes (LKR 2,000 Mn)Withdrawn[SL]A- NegativeN/A

Abbreviations

ASPIAll Share Price Index
bpsBasis points
CBSLCentral Bank of Sri Lanka
CDACoconut Development Authority
CSDCensus and Statistics Department
CSEColombo Stock Exchange
GoSLGovernment of Sri Lanka
SLDBSri Lanka Development Bonds
SLISBSri Lanka International Sovereign Bonds
SOFRSecured Overnight Financing Rate
PMIPurchasing Managers Index
PUCSLPublic Utilities Commission of Sri Lanka
RRISLRubber Research Institute of Sri Lanka
Works Cited
[1]Moody’s Investors Service, “Rating Action: Moody’s downgrades Sri Lanka’s ratings to Caa1, outlook changed to stable,” 28 September 2020. [Online]. Available: https://www.moodys.com/research/Moodys-downgrades-Sri-Lankas-ratings-to-Caa1-outlook-changed-to–PR_431359.
[2]Risk.net, “Malaysia Ibor trades vs SOFR in new sign of Asia transition,” 22 September 2020. [Online]. Available: https://www.risk.net/derivatives/7684751/malaysia-ibor-trades-vs-sofr-in-new-sign-of-asia-transition?utm_content=140550063&utm_medium=social&utm_source=twitter&hssf_channel=tw-78268091.
[3]JICA, “Signing of Japanese ODA Loan Agreement with Sri Lanka: Contributing to the alleviation of traffic congestion in Colombo through urban transportation system improvements,” 11 March 2019. [Online]. Available: https://www.jica.go.jp/english/news/press/2018/20190311_01.html.
[4]Metal Bullatin, “MORNING VIEW: Base metals prices mixed despite encouraging Chinese manufacturing data,” [Online]. Available: https://www.metalbulletin.com/Article/3953763/MORNING-VIEW-Base-metals-prices-mixed-despite-encouraging-Chinese-manufacturing-data.html.

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Email: research@icralanka.com


Disclaimer

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