Benefits Of “Low” Inflation Not Passed

Central Bank of Sri Lanka (CBSL) at Friday’s Monetary Board (MB) meeting kept policy rates unchanged despite inflation moderating. Inflation as measured by a new index that was instituted last month saw the year on year change in inflation come down by 100 basis points to 7.1% compared to May’s reading.
CBSL’s current repurchase (repo) rate is 7% and its reverse repo rate is 8.50%.
But a market source told this reporter that the reason why CBSL didn’t cut down its policy rates despite inflation coming down was because they had those prevailing policy rates even when inflation was at the current “low” levels.
But afterwards when inflation climbed they still maintained their policy rates at those levels, without increasing them, he said. The source however expected a 25 basis point (bp) cut in policy rates by the CBSL/MB at their monthly meeting in September.
Meanwhile the state owned Census and Statistics Department’s new Colombo Consumers’ Price Index (CCPI) has reduced its weightage on the food measurement basket from last month.
However the transparency of the new index cannot be verified, a source said.
It’s alleged that banks’ current lending rates to blue chips are in the region of 8½-9%, while the return on investments (RoI) made by the latter were in the range of 12-13%, giving them “comfortable” margins.
Lending rates to the SME sector were in the region of 11½-12%, while to the micro and SME sector it were in the region of 14%. However with an RoI of 18%, that “outstation” sector too is comfortably off in the current lending rate regime, a source alleged.
Wednesday’s primary Treasury (T) Bill auction saw the yield on the benchmark 364 (one year) tenure fall sharply by 10 basis points (bps) to 7.25% after stagnating at the 7.35% level for several weeks, however a  market source questioned as to whether the benefits of falling yields in the primary auction is passed on to the real economy?
He said that the market for various reasons is forced to invest in gilt edged government securities despite their low yields, mainly at the behest of the customer, and with yields of such falling, that also lowers the Government’s borrowing costs; but the question is whether such declining rates are passed on to the market, to the real economy? the source asked.
Wednesday’s sharp cut in the one year T Bill rate was attributed to Government administered captive funds investing in the same. A proof of this was T Bonds maturing in August 2012 fetching a yield of 7.35% in secondary market trading even on Thursday, a day after Wednesday’s auction, though two weeks ago they were trading at the higher yield of 7.50%.
Government seems to be committed to establishing a low interest rate regime, a source said.
With the market showing an excess liquidity varying from Rs. 50-70 billion virtually daily in the recent past, are also signs that investors are not picking up this excess as fast as one would like to have had seen, thereby debilitating rapid investments growth, even after the war has ended two years ago.
Another reason behind the sharp fall in yields is because the Government’s latest inflationary measurement index which has reduced the weightage on the food basket, has also come down sharply last month, from 8.2% in the point to point index in May to 7.1%, he said. That had also helped to bring down yields.
He further said that during the past month yields of the more liquid 2015 and 2016 T Bonds in secondary market trading had fallen sharply by 75 bps, those too acted as a boost to bring down the one year T Bill yield on Wednesday, he said. Those Bonds at Friday’s secondary market were trading at the 8.62% and 8.75% levels respectively.
However yields of the 2012 T Bonds which were virtually static at the 7.55% to 7.65% levels during this period, came down rapidly by 25 bps to the 7.30%-7.35% levels after Wednesday’s auction results were known, the source said.
Meanwhile yields of the other two tenures on offer at Wednesday’s auction, the 91 and 182 day T Bills, saw a more modest decline of one and two bps to finish at 7.11% and 7.21% respectively.
In the foreign exchange market, sustained pressure forced upon by importers continued, with the Central Bank of Sri Lanka (CBSL) protecting the exchange rate at the Rs. 109/50 levels against the US dollar in spot trading, the source said. If CBSL protection was not there, the exchange rate may well have had depreciated to the Rs. 110 levels, he said.