The central bank is set to keep rates on hold this week when it meets for the second time this year to decide the key policy rate, after leaving the overnight policy rate (OPR) unchanged at its meeting in January.
In January, limited price pressures and, indeed, deepening deflationary conditions, falling interest rates and the recovery in the economy, were proceeding at a strong pace.
In its first policy meeting for 2025, the central bank’s monetary policy board kept the key policy rate – OPR – at 8.00 percent – the level it had retreated to in November last year when it switched from its dual policy rates to a single policy rate.
The statutory reserve ratio (SRR) of banks was also kept at 2.00 percent. SRR is the amount of money that licensed banks maintain with the central bank out of their deposit liabilities.
Meanwhile, First Capital Research, in its traditional pre-policy analysis, expected the central bank to keep its policy rates unchanged at this week’s meeting. It assigned an 80 percent probability of such an event, while the balance was split between a 25-basis and a 50-basis cut.
Its expectation that policy rates will remain unchanged is based on several factors, ranging from sluggish reserve building, due to the settlement of coupon payments on international sovereign bonds, to higher imports, partly from vehicles, and a slowdown in foreign exchange inflows from remittances and tourism trade, as the latter enters the holiday season.
It also said that further rate cuts were not necessary to accelerate economic growth. The budget allocated the largest expenditure, especially capital expenditure, to announce salary increases and pension adjustments for public sector employees, while increasing relief benefits for low-income families who have been disproportionately affected by the economic crisis.
First Capital also cited the already strong growth in private sector debt, despite a contraction of Rs 4.6 billion in January, due to seasonality and still low foreign activity, which has yet to result in a sovereign rating upgrade in December 2024.
“Going forward, we expect foreign investors to remain on the sidelines for the foreseeable future as investors continue to assess new developments. However, we believe that opportunities may arise for foreign investors to invest in government securities in the event that central banks, including those in the US and Europe, continue to cut interest rates (as expected until 2HR 2025), ” it added.
Meanwhile, First Capital saw only a few reasons why the central bank should ease rates further. These were the continued improvement in overnight and outstanding liquidity in the local money market and the increased spread of the yield curve. “With the increase in liquidity levels in the system, coupled with the weakening demand from the SME and micro-enterprise sectors, we believe that another rate cut could accelerate demand for credit and provide a further boost to GDP growth,” it said.
“… We believe that a rate cut could be made to reduce long-term rates, given the significant liquidity levels in the system, in order to take advantage of the low rates, allowing the central bank and the government to raise funds at cheaper rates,” First Capital said, referring to the widening spread between the short and medium-term tenors of the yield curve while both the belly and tail of the curve remain unchanged.
