Eugene Leow, Rates Strategist
Neel Gopalakrishnan, Credit Strategist

DBS Group Research

Rates: Close call on BSP; leaning toward a pause

By many measures, policy settings in the Philippines’ is still too loose. However, we are leaning towards the possibility (just barely) that Bangko Sentral ng Pilipinas (BSP) would stand pat on Thursday after a cumulative 150bps hike thus far this year. Consensus is split. Slightly less than half (including DBS) are calling for a pause while the rest are expecting a 25bps hike. The arguments for another hike are well known. After multiple quarters of strong GDP growth, overheating signs are now apparent in elevated inflation numbers and a deteriorating current account balance. Even after multiple rate hikes, the real policy rate is still negative (-2.2%). Against a challenging global backdrop, tighter policy may be more prudent.

While these risks should be acknowledged (and the BSP may well have to hike more in the coming quarters), we suspect that the BSP will take advantage of this window of stability in the peso and local govvie yieldsto keep rates on hold. Notably, the BSP’s mandate is to maintain price stability and has indicated that CPI may have peaked. This is in contrast to Bank Indonesia (BI) where the mandate is for rupiah stability (in any case, we also think that BI will pause this week). In fact, BSP appears a lot more tolerant of peso weakness and seems more concerned about maintaining growth rates. This dovish slant should not be ignored. Accordingly, the local govvie curve is likely to stay steep as frontend rates stay anchored.

Credit: Sri Lankan bonds under renewed pressure

Sri Lanka sovereign bonds sold off across the curve on Monday as concerns over the country’s political situation increased. Over the weekend, President Sirisena dissolved Parliament and called for fresh Parliamentary elections in January 2019. This follows the sacking of Mr. Wickremesinghe as Prime Minister on 26 October and subsequent suspension of Parliament. Newly appointed Prime Minister Mahinda Rajapaksa was yet to prove that he had a majority in the Parliament. Mr. Wickremesinghe has mounted a legal challenge against the President’s decision to dissolve Parliament, which will also be a test of the independence of the judiciary.

We see the latest development as eroding the credibility of Sri Lanka’s institutional framework. This would be a significant negative, given Sri Lanka’s high external dependence, especially given large near-term refinancing needs (USD15bn of debt is due between 2019 and 2022). It would make it more challenging for the country to access international markets until credibility is restored. In the absence of refinancing transactions, the country would need to dip into reserves, which were only around USD 8.6bn as of August 2018 (4-5 months of imports). It also remains to be seen if the International Monetary Fund would react to these developments. Any delay in releasing further funding under the IMF program raises additional risks. Despite the government’s commitment to meeting near-term bond redemptions (Macro Strategy dated 2 November), we believe bonds would remain under pressure in the near term, more so with broader market sentiment being fragile. We continue to recommend staying cautious on Sri Lankan bonds.

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