Real rates marginally positive so lending is the way to spur growth: CT CLSA

As real rates are marginally positive, lending to private sector companies is the way to spur growth in the economy which has been badly hit by Covid-19, said CT CLSA on Thursday (9) following the Central Bank’s latest policy interest rate cut.
“Although the recent interest rate reductions are likely to reduce the market interest rates in the near term by a further 20bps to 30bps, given the fact that the economy operates on marginal positive real rates of +32bps (National Consumer Price Index [NCPI] estimate for end-June 2020 of 5.0% versus the 12-month Treasury bill of 5.32% as of 9 July 2020), we believe further rate cuts won’t sustain below the current level, although the current stimulus was required to spur credit growth in the near term,” CT CLSA said.
The Monetary Board of the Central Bank of Sri Lanka (CBSL), at its meeting held on 8 July 2020, decided to reduce its Standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR) – together referred to as policy interest rates – by a further 100bps to 4.5% and 5.5% with effect from 9 July 2020, respectively. This results in policy interest rate cuts amounting to 250bps and Statutory Reserve Ratio (SRR) cuts amounting to 300bps in 2020 year to date (YTD).
CT CLSA said it is maintaining its interest rate forecast for a 12-month Treasury yield at 5.5% as at 31 December 2020E whilst maintaining its LKR/USD forecast at 195/$ as at 31 December 2020E, despite the cut in policy interest rates by the CBSL.
The CBSL indicated that these policy measures to date were implemented in order to kick-start relatively low credit growth as of now, whilst hinting 2Q2020E real GDP growth numbers to be significantly impacted by the Covid-19 pandemic. With private sector credit growth declining to 6.4% year on year (YoY) in May 2020 from 7.6% in April 2020, amid some indications of crowding out, the CBSL believes that last week’s 100bps rate cut will spur private sector credit growth amid extremely high liquidity levels in the financial market as of now.
Despite the CBSL and the Government’s efforts to improve economic activity, owing to Covid-19 and relatively high non-performing assets (NPAs) in the system, the banking sector was reluctant to lend to businesses (indicated by the extremely low margins made via corporate financing). However, with the release of liquidity via SRR cuts and freshly minted money, the CBSL is likely to supervise the lending process of large commercial banks in order to stimulate economic activity under the recently announced 4% credit facilities that will be guaranteed by the CBSL, CT CLSA said.
“With the Government of Sri Lanka likely to receive concessional funding worth $ 1 billion from the Federal Reserve (Fed) in the near term (which is at the discussion phase as of now) amidst gross official reserves at $ 6.7 billion as of end-June 2020, the country remains in a comfortable space to honour its short to medium-term external debt obligations with minimal sovereign default risk,” it added.