Pakistan reduces interest rate by 25 basis points

On 21st May 2016 State Bank of Pakistan (SBP) issued Monetary Policy Statement for next two months. It has attracted mixed reaction, some term it too little and too late, while many term it a surprising move. However, a few term it an anticipated move and the evidence was rejection of all the bids received in the recent auction of Pakistan Investment Bonds (PIBs).

Many of the financial sector experts were under the impression that in May the SBP would increase the policy rate. This mindset was evident in PIB auction and SBP stance demonstrated though rejection of all the bids. However, one completely fails to understand the logic behind 25 basis point reduction. If the PML-N government is serious in boosting GDP growth rate, it has to reduce the policy rate minimum by 100 basis points.     

It is pertinent to note that SBP last cut the rates by 50bps in September 2015 and since then it has been maintaining status quo in subsequent announcement. SBP forecasts headline inflation (CPI) to remain within targets for the CY16 and going into CY17 to gain upward momentum. However, missed GDP growth target of 5.5% remained major concern and rate cut is expected to help spur growth.

Even though the inflation has been on the rise for past 7 months, SBP expected the outlook to remain low for CY16. However, with rising oil and commodities prices and expected imposition of certain tax measures by the Government in upcoming budget the SBP forecast the inflation to gain upward momentum in CY17. 

Large Scale manufacturing (LSM), mainly supported by construction and consumer durables, automobiles, fertilizers, and cement production, grew 4.7% in the July-March CY16 compared to 2.8% a year ago. The growth is expected to gain further on the back of improved electricity and security situation, according to SBP.

SBP also noted stability in balance of payments and upward trajectory in foreign exchange reserves on account of healthy workers’ remittances and lower international oil prices to keep the situation within manageable levels. Furthermore, SBP remained optimistic on external front, likely on account of continued workers’ remittances and bilateral inflows owing to various projects under CPEC.

Equity markets in general would perceive 25bps cut optimistic as it inflates the valuation especially for highly leveraged companies and sectors. Analysts maintain their likeness for cement, fertilizer, textile and other manufacturing base sectors which would remain in limelight going forward. Margins for banking sector are likely to shrink further thus putting banks under pressure. However, their profitability is likely to remain intact due to revaluation gains in PIB's portfolio.

Some market analysts see room for further reduction of rates, to spur growth. However, many expect SBP to keep rates on hold in near future, owing to rising inflation. A marginal upward move in inflation figures in upcoming months would be in line with SBP estimates. However if those numbers inflate somehow, SBP will have to revisit its rates policy sooner than later.

State Bank of Pakistan could not gather courage to cut policy rate

On Saturday, 30th January 2016 the newly constituted Monetary Poly Committee (MPC) of State Bank of Pakistan (SBP) decided to keep the Policy Rate unchanged at 6.0 percent. This was a little disappointing for those, hoping against the hope. The general perception was that the MPC will find reasons for not announcing the cut, and this happened. Interesting is the review of the economy but disappointing is the decision as it shows inability of the policy makers to take an appropriate decision.

The good points of the review of economy by the SBP are as follows:

The major macroeconomic indicators continued to exhibit improvements in the first half of the current fiscal year. The inflationary environment stayed benign, LSM gained traction, and fiscal consolidation remained on track. In addition, successful completion of ninth review under IMF’s EFF and disbursements from multilateral and bilateral sources added on to country’s external buffers. With the pickup in private sector credit, for fixed investment in particular, along with improving security situation reflects strengthening of investor and consumer confidence.

Average CPI inflation declined to 2.1 percent during July-December 2015, with perishable food items and motor fuel leading the way. Meanwhile trend in YoY CPI inflation has reversed; it rose for third consecutive month to 3.2 percent in December 2015. Keeping in view the benign outlook of global commodity prices, expectation of a moderate pickup in domestic demand and further ease in supply side constraints, SBP expects the average inflation in FY16 to remain in the range of 3 to 4 percent. However, global oil price trends and excess domestic food stocks (wheat, rice, and sugar) may exert downward pressures on inflation.

Large-scale manufacturing (LSM) grew by 4.4 percent during Jul-Nov FY16 as compared to 3.1 percent in the same period last year. LSM mainly benefitted from monetary easing, falling international prices of key inputs, better energy situation, increased domestic demand for consumer durables, and expansion of construction activities. There are challenges to overall economic performance from the declines in the production of cotton and rice. However, a part of these losses could be offset by better performance of other crops, especially from the upcoming wheat crop. In view of these developments, real GDP is set to maintain the previous year’s growth momentum. The uptick in economic activity appears to continue beyond FY16 on the back of energy and infrastructure projects under CPEC.

Pakistan’s overall balance of payment position continued to strengthen during H1-FY16. The external current account deficit narrowed down to almost half of the last year’s level on account of persistent decline in international oil price and steady growth in workers’ remittances. In the capital and financial accounts, besides strong official inflows, there is some improvement in foreign direct investment.

Given depressed outlook of international commodity prices, the external current account deficit is expected to remain lower than last year. With continuation of the IMF EFF and expected disbursements from other official sources, the surplus in capital and financial accounts may increase in the second half of FY16. These are expected to have favorable impact on foreign exchange reserves. Furthermore, expected increase in FDI from China may help maintain an upward trajectory in foreign exchange reserves. Reversing of trends in exports, however, is dependent on external demand and cotton prices in international market. In addition, easing of domestic constraints with the completion of ongoing energy projects could help in improving export competitiveness.

Fiscal deficit was contained to 1.1 percent of GDP during Q1-FY16, compared to 1.2 percent in the same period last year. This reduction, despite substantial increase in development expenditures during Q1FY16, was due to improvement in tax revenues and containment of current expenditures. The improvement in fiscal accounts may continue in the remaining months of FY16. While additional tax measures announced in October 2015 are expected to contribute to growth in FBR revenues, current spending is likely to remain within target.

The year-on-year growth in broad money (M2) accelerated largely due to substantial increase in Net Foreign Assets (NFA) of the banking system. The growth in Net Domestic Assets (NDA) of the banking system decelerated despite a pickup in private sector credit. On the liability side, deceleration in growth of deposits and acceleration in currency in circulation are source of concern.

The credit to private sector increased by Rs339.8 billion during H1-FY16 as compared to the Rs224.5 billion in same period last year. The impact of monetary easing, improved financial conditions of the major corporate sector and better business environment encouraged firms to avail credit not only for working capital requirements but also for fixed investments. Going forward, the improvements in LSM, expansion plans announced by major industries and favorable monetary conditions are expected to provide continued momentum in the demand for credit.

Some stress in liquidity noticed in Q1-FY16 due to increased government borrowing from the scheduled banks steadily eased in Q2-FY16 owing to improved revenue collection and timely receipt of foreign flows. Besides this, pressures in foreign exchange market also induced volatility in interbank liquidity requirements. This is also evident from movements in overnight repo rate which mostly remained slightly above the SBP target rate.