State Bank of Pakistan Maintains Policy Rate At 6.0%

Arif Habib Limited.

State Bank of Pakistan (SBP), as per our expectation, opted to wait and watch the impact of its last rate cut (Sep’15) for another two months, and decided to maintain Policy Rate at 6.0% in its November 2015 Monetary Policy Statement, last Saturday 21st of Nov’15. The rationale for status quo circled around: (i) expected pickup in headline inflation, (ii) improved external sector outlook, and (iii) expected continued uptake in private sector credit cycle, along with an improving LSM growth.

Upward projection of Headline Inflation

The subdued global oil prices along with other major commodities may continue to dictate annual average inflation at lower levels (our FY16 estimate of 4.3%), however, the headline inflation is expected to pick up from current levels mainly due to low base effect. Key risks to our inflation thesis remain expected recovery in oil prices and rising commodities prices.

Nominal Increase in Private Sector Credit coupled with LSM growth  

Private Sector credit noted a growth of 0.49% for 10MCY15, compared to a decline of 0.12% in 9MCY15, showing signs of entering an uptake phase of the credit cycle. Large Scale Manufacturing (LSM), on the other hand, showed a growth of 3.9% YoY in 3MFY16, compared to only 2.6% SPLY. Further boost to this growth is expected from expansion in construction activities, automobile production, and improving energy supply on the back of recent LNG imports and various energy projects in the pipeline.

Improving External Account Outlook

Current Account Deficit (CAD) has narrowed down 72% YoY to USD 532mn in 4MFY16 compared to a deficit of USD 1,900mn SPLY. The CAD contracted despite a 10.6% YoY decline in exports, due to a substantial decline in oil imports – thanks to lower international oil prices. However, Oct’15 CAD of USD 416mn was predominantly driven by the absence of Coalition Support Fund (CSF) inflows and lower workers’ remittances. In our view, external account outlook is strong in the medium to longer term based on sustained support from the lower oil prices, and cash inflows from CSF, ADB (USD 1.4bn), World Bank (USD 500mn), and IMF (USD 500mn). It would be prudent to assume the current account to stay under pressure in the short term due to subdued workers’ remittances and recent cut in domestic cotton production estimate which may lead to increased cotton imports.

Recommendation

We expect the status quo stance on monetary policy for the next two months by SBP will be a non-event for the market. However, activity in banking sector could pick up attributable to investors believing interest rates have bottomed out, thus NIMs could rise going forward. With bottomed out interest rates, we expect the PIB/MTB yields to recover going forward as GoP will look to finance its upcoming debt payments. That coupled with uptick in Banking spreads noticed last month, we see positive outlook for banking sector. In addition, banking sector occupying ~20% weight in the benchmark index could change the market sentiments and aide the equity market to post gains. Our top picks in AHL banking universe remain UBL, HBL and BAFL. In addition, we have a strong liking for dividend yielding stocks as KSE100 offers a decent 6.2% versus regional DY of 2.5%. Pakistan’s equity market is currently trading at a forward PER of 8.7x (regional multiple of 12.5x, a discount of 36%).