Inside Financial Markets

Monetary policy: Status Quo or 50 bps rise? Research Reports

 monetary policyMonetary policy: Status Quo or 50 bps rise?

 Pakistan interest rate: Status Quo or 50 bps rise : Topline Research

Following the policy of giving relatively high priority to ease inflation and to ignite growth, SBP has gradually reduced discount rate from 14% to 9% in 2 years span.  During the period, the policy caused bond and stock prices to rally in Pakistan. However, the upcoming monetary policy meeting will be testing time for the 10-member SBP Central Board in light of likely increase in inflation coupled with upcoming IMF board meeting to approve much-needed new loan for Pakistan.

We believe that higher than expected CPI for July, falling PKR and IMF prior actions would be the key factors before the board this time. Last CPI (8.26% July CPI lower than 9% policy rate) number does not warrant rate revision in upcoming monetary policy. However, unofficial pressure from IMF as a pre-condition for loan approval coupled with argument that inflation can rise in coming months may force SBP to hike rate by 50 bps, we believe.

Yet, it will be a tough task for the board members to reverse the earlier decisions of monetary easing in a span of 2 months but we feel slightly higher probability of 50bps rise and lesser chance for status quo. In case of status quo, SBP may give a signal (especially to IMF) to review rates in next MPS after evaluating actual CPI of few more months after Ramadan, Federal Budget and energy prices impact. However, we rule out immediate 150bps hike as reported in local newspapers considering average inflation likely to remain in single digit in FY14.

Markets have incorporated approx 50bps rise

The increase in the policy rate is negative for stock valuations and earnings of leveraged companies and for the overall economic revival that was expected after the induction of business friendly PML-N government. However bond and equity markets have already incorporated 50bps rate hike, we believe. Banks have recently showed their preference for short duration papers in T-bill auction as 1-year T-bill yields have already increased by 40bps and 10-year bond yield by 110bps since July 2013.

Inflation will increase; but how much?

This is the main issue at hand, as IMF inflationary expectations could be different from SBP. Average CPI inflation was at 7.4% in FY13 much lower than government’s target of 9.5% and SBP’s initial target of 9.1%. With new govt initiatives to increase tax revenue (especially 1% sales tax) and  power sector reforms (electricity and gas rates to go up substantially), we expect inflation to climb up in FY14 to range between 9-10%, higher than govt target of 8% but still manageable. Taking our estimates as base case, real interest rate can be slightly negative, if policy rate is kept unchanged.

IMF prior actions

Similar to the previous IMF SBA (Stand-By Arrangement) in 2008, IMF has required Pakistan to introduce power reforms, broaden tax nets, increase revenues and curtail fiscal deficit. As a pre-condition (or prior action) these reforms include rationalization of power tariff, resolution of circular debt and curtailing subsidies while govt is also required to reach an understanding with the provinces on budget surplus and issue notices to 10,000 potential taxpayers. There are media reports, though not confirmed from reliable sources, that govt has also agreed to increase discount rate by 150bps as the fund still believes that inflation will revert back to double digit in coming months. In 2008, govt increased discount rate by 200bps to meet IMF “prior action” condition. Government has already fulfilled many of these pre-conditions including devaluation of PKR by 3% since July 2013. That is why markets are speculating on increase in interest rate.



SBP to increase discount rate by 50-100bps : Global Research


We anticipate SBP to increase discount rate by 50-100bps in the upcoming monetary policy due to concerns over inflation and IMF precondition to tighten monetary stance. CPI inflation in Aug13 is estimated to clock in at 8.65% YoY against 8.26% last month, which will bring down real interest rates to less than 50bps. During the last two years, real interest rates have averaged around 150bps. Moreover, IMF has also raised its concerns over inflation outlook and have demanded hike in interest rates according to news reports. This may also propel SBP to increase policy rate in the upcoming monetary policy scheduled on Sep 13’13 as Pakistan is likely to receive the IMF loan tranche in the first week of Sep13.

Recall, Pakistan has met all other IMF preconditions (hike in power tariffs, measures to increase tax revenues, decline in SBP intervention in forex market). We wait for Aug13’s inflation numbers that would further bring clarity in this regard.

 Bond yields up on DR hike concerns; what’s the verdict : KASB Research

Recent uptick in PIB yields (up 60bp FY-to date), and last T-bill auction bid pattern suggest that the bond market is anticipating a discount rate hike as early as Oct-13. These expectations are driven by:

(1) Multi-year high M2 growth of 17.2% in FY13 (2) expectations of CPI trending upwards from Jul-13 and (3) IMF’s mandate in recent Pak-IMF loan agreement, which whilst ambiguous, calls for central bank actions.

In our view, SBP’s decision to cut DR in Jun-13 (to 9%) in the midst of IMF-Pak parleys, dilutes the case of any IMF-mandated hike in rate prior to loan approval in Sep-13.

In addition, consistency in monetary policy stance suggests CPI inflation trend should continue to receive higher weight in SBP’s decision-making. Given that real rates are expected to remain positive in 2H13E, this reinforces our stance of potential status quo in 2H, with rate hike in early CY14E.

Just to summarize all the news flow on IMF, Rupee Exchange Rate and Interest Rates : JS Research

Some inconclusive news on the potential IMF loan (US$6.6bn) and prior actions (continued purchase of US Dollars by SBP from the market vs. requirement to hike interest rates). Uncertainty on this has stemmed from SBP’s decision to hold a much delayed Monetary Policy Statement (MPS) on 13 September, 2013 rather than in August (as was the earlier MPS schedule) while the comments of Pakistan’s Finance Minister (FM), Mr. Ishaq Daar in a press conference yesterday have also proved to be interesting. Crucially, the MPS will now be after the IMF Board sits down with Pakistan’s case on 6 September, 2013 suggesting that the change in date gives the government and SBP some wiggle room for the MPS after the IMF considers whether they have done enough. The upcoming interest rate decision will also now factor in August CPI inflation (which we anticipate at 8.45% after 8.3% in July 2013). We continue to see unchanged interest rate in the upcoming MPS.

Just to summarize all the news flow on IMF, Rupee Exchange Rate and Interest Rates:

As per media reports, the Finance Minister stated on Monday that Pakistan has met all prior actions for the US$6.6bn IMF bailout program “while the last action has been met by half and the rest would be implemented by SBP very soon”. He categorically ruled out any increase in discount rate by the SBP in the monetary policy. That said, the FM also brushed off speculation that recent depreciation of the PKR vs. USD was the result of an understanding with the IMF so we may have to take his comments with a pinch of salt.

In tandem, or perhaps as a result, media reports now suggest that the IMF has accepted Pakistan’s request to delay the first interest rate hike at least till the Fund’s first review meeting. It is not yet clear when exactly this will be. Note Pakistan has applied for the IMF loan under the Extended Fund Facility (EFF) which has flexibility in the frequency of reviews based on the strength of the country’s policies and the nature of its financing needs. (KSE should react positively if we see status quo on interest rates barring Banks).

Reportedly, in return for the delay in rate hike, Pakistan  will triple the amount of US Dollars required to be mopped up from the open market to build foreign currency (FX) reserves. Recall one of IMF’s required prior actions at the time of the Staff Level Agreement (early July 2013) was that SBP build up more acceptable FX reserves by buying back US Dollars from the market. Reportedly, Pakistan was supposed to buy US$125mn and increase the interest rate by min. 100bp. Now the foreign currency purchase has been increased to US$375mn. (Implies pressure on Rupee may continue in near term so can make a case for rate sensitive co’s like textile and power).

On a separate note, Pakistan will seek US$12bn in loans from international financial institutions (including IMF) over the next 3-years to retire its previous debts. Note that proposed loans already stand at US$9.7bn (including US$6.6bn IMF; US$1.5bn World Bank; US$1.1bn IDB and US$0.5bn ADB) where if these committed flows materialize, additional loan amount to rustle up will be relatively manageable. On Monday, Pakistan re-paid US$393mn to the IMF as the 19th installment of the 2008 SBA. This is the 4th SBA repayment in FY14 (total repayment FY-to-date: US$792mn) where the next payment of US$146mn is due on 27 September, 2013. (Suggesting market should not go into full-on panic mode on currency and Rupee should stabilize October 2013 onwards).


Sanie Khan

Sanie Khan holds a deep knowledge of the financial markets in Pakistan. Based in Karachi, he has over 20 years of hands-on management experience in financial technologies and managing operations in the financial sector. He was the General Manager at the Pakistan Stock Exchange (PSX) for 17 years. He along-with senior members of Exchange

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