Reduction of 25bps expected

Karachi, September 13, 2019: While most of the analysts are expecting status quo in upcoming monetary policy, analysts at Arif Habib Limited are seeing some 24 basis points cut in interest rate.

The State Bank of Pakistan (SBP) is scheduled to announce its monetary policy on September 16, 2019.

“We expect the central bank to lower its policy rate by 25bps to 13.00 percent”, Samiullah Tariq of ARIF Habib said.

Primary reason for this decline in policy rate, in our view, is the decline in FY20 expected inflation from 10.7 percent to 9.6 percent due to rebasing of CPI from 2007-08 to 2015-16, he added.

To recall, previous rate hike of 100bps in Jul’19 was on account of higher inflationary forecast and one time adjustment in utility prices. Despite adjustment in utility prices, change in weights of gas and electricity in CPI methodology resulted in lower inflation of previous and current year.

He said that after rebasing, average inflation for 1QFY20 is expected to settle at 9.92 percent, while a policy rate of 13.25 percent would result in a real interest rate of 333bps. Data for the past 48 months exhibits that average real interest rates have remained approx. 2.1 percent. Therefore, we believe rate cut of 25bps in upcoming monetary policy would still keep real interest rates at 3.08 percent, Tariq said.

Money Market Incorporated Decline in Interest Rates

The yield curve has shifted downwards towards the longer end of the curve, whereby the yields for 10-yr PIB have declined by 136bps since Jul’19.

The T-bill auction held on Wednesday (September 11th, 2019) was also extraordinary as 87% of the total participation was made in one year T-bills, showing that market participants wanted to lock-in their rates for one year as they foresee a decline in interest rates during the period.

The result of the auction exhibited that the cutoff for 1-yr T-bill was lower by 32bps, while the remaining didn’t change much. In the secondary market trading, the yield for 1-yr T-bill has declined to 13.52 percent, which is a further decline of 41bps since the cutoff. One plausible explanation for this move is that the government only realized 24 percent of bids for the 12-month paper, which meant the remaining bidders came to to purchase the paper.

Decline in cutoff for T-bills as well as movement in secondary market for T-bills and PIBs are pointing towards a cut in discount rate in the upcoming monetary policy.

25bps Cut in Policy Rate is Expected

On the external front, the Current Account Deficit witnessed a substantial decline of 73 percent YoY to USD 579 million in Jul’19. Meanwhile, CAD has reduced down to a sustainable level of around 2.5 percent of GDP due to a massive decline in imports as the incumbent government continues to undertake several corrective measures. On the other hand, exchange rate is now stabilizing between PKR156/USD to PKR158/USD.

We believe domestic demand has already been compressed as witnessed in the declining statistics of imports (-22 percent for 2MFY20) and sales of consumer durables (Autos -42 percent YoY, Electrical Appliances, etc). We expect the SBP to reduce the policy rate by 25bps citing lower than expected inflation and reduction in interest rates globally. We also expect a further 100 bps rate cut during FY20 which is expected in Mar’20 and May’20 by 50bps each.

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