Bond traders divided over a change in Sri Lankan interest rates

Apr.11 (LBO) – Sri Lanka’s Central Bank is unlikely to cut interest rates this month, though some traders are expecting a 25 basis point cut.

-Mel Gunasekera: mel@vanguardlk.com

The repurchase rate currently stands at 8.75 percent and the reverse repurchase rate is at 10.25 percent.

The repurchase rate is the return on cash deposited by commercial banks with the central bank and the reverse repurchase rate is the cost of borrowing from the Central Bank.

Following the monetary board meeting, the bank is due to announce its monthly monetary policy announcement early Wednesday morning.

However, opinions are divided, with some traders anticipating a quarter percentage cut, based on declining inflationary trends.

The majority, however, remains sceptical that the bank will leave policy rates unchanged for this month, and instead move to reduce it mid-this year.

The bank raised key interest rate by 1.25 percentage points in four stages in 2005, to cool inflationary pressures brought about by excessive credit expansion.

Since then, inflation eased to a 14-month low of 9.6 percent, giving the bank room to cut rates to encourage economic expansion.

While further downside in inflation appears likely in the short term, a potential hike in fuel retail prices could give a one-off push to inflation.

Central Bank has said earlier that a 10 percent rise in fuel prices could have a 1.5 percent impact on the consumer price index.

Retail fuel prices have not been adjusted since June 2005 due to political pressure, but with no elections lined up in the short-term, gives room for prices to be raised and reflect global prices.

“Global crude oil prices, which at around US$67/barrel at present, are only 5-percent off their record highs set last September,” notes economist Channa Amaratunga of Boston Asset Management.

“We believe that Central Bank will defer such a decision until the situation vis-à-vis any potential petroleum retail price hikes and their likely impact on inflation becomes clearer.”

With the economy also depicting steady growth momentum, of a robust 6.3 percent during the last quarter of 2005, Amaratunga says there is little necessity to cut rates to kick-start the economy.

Since Wednesday’s announcement is too close to call, the bond market is not taking chances with longer tenures on government treasuries creeping up in the past two weeks.

“My view is that it is too early to cut in April, however, we have positioned ourselves for a possible cut,” said Dudeepa Ratwatte MD/CEO First Capital Asset Management.

However, credit expansion, will remain a cause for concern, as locals go on a borrowing binge because interest rates are below inflation.

“Bulk of today’s consumer credit expansion has been driven by mainly foreign banks tempting people to buy cars, televisions and build houses,” notes Ajith Fernando, CEO Capital Alliance Holdings.

Broad money growth is hovering around 22 percent, according to Central Bank figures and Fernando says it should come down to between 15-16 percent before the bank can make a clear decision to revise interest rates downwards.

“The way things stand, Central Bank is not doing too bad, there is no need for an immediate change in rates,” Fernando said.