Policy rate cut surprising move
* Growth gets priority over inflation – Analysts
December 12, 2012, 8:52 pm
The Ministry of Technology and Research conducted the "Reconciliation through Technology & Research" initiative on December 10 and 11, 2012 at the Open University of Sri Lanka- Jaffna Regional Centre. The institutions under the preview of the Ministry were able to establish new tie ups with the industry representatives of the area while promoting closer collaboration between them.
Several Technology transfer workshops were held during the two days covering effective building, food safety measures and Palmyrah extraction. The Secretary to the Ministry of Technology and Research Dhara Wijetilleka who declared open the Technology exhibition is seen speaking to a young inventor from Jaffna who had his invention exhibited during the exhibition. A cutting knife, which can be used at night during power failures. The knife and the chopping board are illuminated with battery operated LED bulbs ready to be switched on during a power failure.
The Central Bank’s 25bps monetary policy easing was seen as a surprising move, especially with the government’s heavy domestic borrowings requirements next year, analysts said.
"In an unexpected move, the Central Bank of Sri Lanka (CBSL) reduced its repo and reverse repo rates by 25bps each to 7.5% and 9.5% respectively today, after adopting a tight monetary policy since April 2011. Further, the CBSL stated in its policy review that "the credit ceiling imposed (on Licensed Commercial Banks) for 2012 has served its purpose and such a policy measure may not be required in the near future," CT Smith Stockbrokers said in a special report yesterday (12).
"Despite credit growth and balance of trade deficit decelerating to healthy levels, partly owing to the tight monetary policy adopted by the authorities especially during 1H2012, the rate cut came in as a surprise with country’s headline inflation remaining sticky at high single digits (November 2012 point-point inflation rose to 9.5% from 8.9% in October 2012). With the CBSL revising its GDP growth forecast down to 6.8% for 2012E from 7.2% previously, we believe that the authority is likely to prioritise growth over inflation in 2013E as the rate cut came in earlier than expected. While the rise in food prices in the recent months occurred due to supply side issues, we believe inflation should correct in the near term on account of more normal weather conditions.
"We however expect further rate cuts to stimulate investments (as investment to GDP ratio in the broader economy is expected to be stimulated only by relatively larger dips in AWPLR and T-bill yields) in order to boost economic growth in the medium term. Consequently we expect interest rates to decline (with 12M average T-bill yield slightly revised down to 12.9% in 2013E from 13.0% previously) in the short term (1H2013E) but rise in 2H2013E owing to expected crowding-out in the private sector borrowings on account of the shift in the Government of Sri Lanka’s 2013E deficit financing mechanism.
"While lower short term interest rates would naturally benefit highly geared companies (although not directly addressing operating level weaknesses) and encourage greater demand for credit, other beneficiaries also exist; - Businesses which depend on (low cost) debt capital to promote sales, i.e. land and property, motor vehicles, consumer durables etc., should benefit as sales are likely to improve amidst lower financing costs. - Leasing companies which run a maturity mis-match (i.e. borrow short-variable, and lend long-fixed) will benefit from a lower rate environment improving their NIMs, apart from the benefits of greater demand for credit. The reduction in interest rates should meanwhile boost equities, by both encouraging a switch from fixed income instruments into equities and by increasing corporate profits of debt-carrying companies," CT Smith Stockbrokers said.
Earlier, economists had been skeptical the Central Bank would have enough space to ease monetary policy.
No foreign commercial borrowings...
The government proposes not to go for any foreign commercial borrowings next year, according to the 2013 budget, but domestic non bank borrowings will surge in order to finance a growing fiscal deficit.
According to 2013 budget proposals the government will not seek foreign commercial loans next year after borrowing Rs. 109.5 billion in 2011 and Rs. 128 billion in 2012.
With the budget deficit estimated at Rs. 507.4 billion next year, the government hopes to raise Rs. 86 billion from foreign sources to finance the deficit, a sharp decline from Rs. 205.6 billion estimated for this year, while domestic borrowings are estimated at Rs. 421.4 billion, almost doubling from 259.6 billion in 2012.
Non bank domestic borrowings are expected to carry the weight of the deficit, surging to Rs. 289.4 billion next year from 84.6 billion this year.
"Non bank borrowings will be high next year. This means more funds would be mobilised by selling Treasury bills and bonds to the public and borrowing from EPF, NSB and Sri Lanka Insurance," Institute of Policy Studies Executive Director Dr. Saman Kelegama said, addressing a post budget seminar organised by the Sri Lanka Economic Association and Alumni Association of the University of Peradeniya (Colombo Branch) last month.
"For such borrowings to be effective interest rates would have to be attractive and this, among other factors, implies there is limited space for a reduction in policy interest rates," he said.
Dr. Kelegama also pointed out there was limited headroom for additional commercial borrowings from abroad to boost investment and growth.
"Public debt as a percentage of GDP may have declined from 80 percent to 78 percent in 2012, but the stock of foreign debt in total public debt has increased from 7.3 percent in 2003 to 37.5 percent in 2010, thereby raising risks associated with the economy. The share of commercial debt in total public debt has also increased. Within that, the external short-term debt has increased. As a result, despite the decline in the stock of government debt as a percentage of GDP, the external debt service ratio is heading in a risky direction," Dr. Kelegama said.
The government’s fiscal policy is under strain this year because authorities failed to take early action to rectify a balance of payments problem last year.
The budget deficit as a percentage of GDP for the first nine months of this year reached 6.44 percent, exceeding the full year’s target of 6.2 percent, as government expenditure grew nearly twice as fast as revenue growth, latest data released by the Central Bank showed.
Tax revenue grew 6.55 percent year-on-year to Rs. 629.5 billion during the first nine months of this year. Non tax revenue reached Rs. 81.8 billion growing 16.19 billion while grants surged 48.48 percent to Rs. 14.4 billion.
Recurrent expenditure grew 9.07 percent to Rs. 851.8 billion while capital expenditure increased by 31.84 percent to Rs. 356.9 billion.
Total government expenditure was up 14.93 percent to Rs. 1,208.7 billion.
The budget deficit for the period January to September 2012 reached Rs. 483 billion, a 26.87 percent increase from the previous year. As a percentage of GDP, this deficit stood at 6.44 percent, as against 5.81 percent a year ago.
The government’s total outstanding debt stock as at end September reached Rs. 6,262 billion, an increase of 23.52 percent from a year earlier. Domestic debt grew 16.15 percent to Rs. 3,280.4 billion while foreign debt grew 32.79 percent to Rs. 2,981.5 billion.
Total outstanding government debt grew by Rs. 1,128.6 billion during the first nine months of this year. According to the 2012 budget, the government’s borrowing limit for the full year is Rs. 1,104 billion.
According to the 2012 budget, the government’s debt requirement for 2012 was Rs. 776.2 billion from domestic sources and Rs. 327.8 billion from external sources. However, by end September 2012, the domestic debt component grew by Rs. 476.2 billion from end December 2011 while foreign debt increased by Rs. 652.2 billion.
Moody’s in a recent report said: "According to sovereign ratings agency Moody’s the country’s low government financial strength is constrained by a high debt burden and a high cost of servicing debt.
"Budget deficits are large, although on a gradually declining trend. Losses of state-owned enterprises also contribute to the country’s low savings rate, which at 22% of GDP is well below the investment rate of 30%.
"Averaging 7.9% of GDP between 2001 and 2011, deficits are well above the B- median average of 2.6%. However, the consistent moderation in the deficit from a peak of 9.9% in 2009 to 6.2% and 5.8% budgeted for 2012 and 2013 respectively, demonstrates the government’s commitment to and success in fiscal consolidation.
"Revenues, at 14.2% of GDP in 2012, are the lowest amongst rating peers, barring Cambodia (B2), Dominican Republic (B1) and Pakistan (Caa1). In the past, this has been due to a weak tax base since the Northern and Eastern areas saw little economic activity. While the government has taken steps toward simplifying and broad-basing the tax system, this has not yet translated into a marked improvement in revenue collections," Moody’s said in a special report last week (See The Island Financial Review Saturday, November 17).
"While the projected consolidation in 2013 is encouraging, as in the past, implementation will be key. To this end, achieving targets looks difficult, given that assumptions are based on (a) an ambitious 19.2% increase in revenues (vs. a 14.6% average increase between 2001-11) to 14.5% of GDP in an environment of slowing growth and (b) nominal GDP growth of 15%YoY (this factors in real GDP at 7.5%, vs. our estimate of real growth at 6.5% and nominal growth at 14.4%). We expect slippage to the tune of 60bps to the 5.8% deficit target," the ratings agency said.