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SL Policy rates may have to be eased further: Fitch 

24 May 2021

Fitch continues to expect the Central Bank of Sri Lanka (CBSL) to maintain its current monetary policy stance and keep its standing Deposit Facility Rate (SDFR) and Standing Lending Facility Rate (SLFR) at 4.50% and 5.50%, respectively, through 2021 but see downside risks to their forecast should the country impose more stringent or protracted containment measures in a bid to contain the outbreak.  “Additionally, we will also be paying close attention to private credit data. Spurred on by low-interest rates and a positive economic outlook, private credit uptake rose to 6.9% Y-o-Y in Jan 2021. Should credit growth to the private sector decelerate significantly or even turn negative due to the heightened economic uncertainty from the third wave, monetary policy conditions may have to be eased further,” Fitch added in a recent report.  CBSL maintained its SDFR and its SLFR at 4.5% and 5.5%, respectively, during its monetary policy meeting on May 20. In its accompanying statement, the CBSL struck a somewhat optimistic tone despite a resurgence of the third wave, highlighting that ‘the adverse effects on economic activity are expected to be lesser than during the first two waves due to the selective nature of mobility restrictions and the ongoing vaccination drive’.  Fitch noted that the CBSL’s decision to maintain its current monetary policy settings despite the increasing risk to the country’s economic recovery implies that it intends to take a wait-and-see approach from now.  To support economic activity amid the Covid-19 pandemic, the CBSL has already reduced its benchmark policy rates by 250bps in 2020. As pointed out in previous monetary pieces, one of the reasons the CBSL would like to hold off additional monetary easing as much as possible is because such a move would further reduce the attractiveness of Sri Lankan assets.  This comes at a time when Sri Lankan Government bonds are already undersubscribed amid the country’s shrinking foreign reserve, which has undermined its soft currency peg. Moreover, Fitch noted that while the resumption of the third outbreak has led to the government implementing stricter containment, important economic sectors, such as apparel and agriculture have thus far been exempted. Indeed, the Government’s strong reluctance to impose an islandwide lockdown will likely help mitigate the adverse economic impact of the pandemic, preventing the need to further ease its monetary policy settings.  “Nevertheless, while the Government is unlikely to impose a nationwide lockdown due to economic concerns, we remain cognizant that the resurgence in Covid-19 cases and the reimplementation of containment measures similar to that experienced in 2020 will still deliver a blow to the economy. According to Our World in Data, the stringency index (a composite indicator to measure the severity of restrictions, scaled to 100), currently stands at 86.11, slightly below the peak of 100 that the country registered in April 2020 due to national lockdown measures,” it added.  This will no doubt weigh on domestic demand and threaten the recovery trajectory for the economy. As such, Fitch will revise their growth outlook for Sri Lanka from 4.8% in 2021 to 4.2%., following the economy’s 3.6% contraction in 2020.


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