– SBP effectively cuts policy rate by 150bp- Contrary to market expectations, the State Bank of Pakistan (SBP) announced its most aggressive monetary easing move of the last few years on Saturday, reducing the SBP policy rate effectively by 150 basis points (bp) to 6.5%.
Equity markets are likely to react positively, as it was pricing in only a 50bp point cut. A Bloomberg survey of 15 economists before the MPS showed only one expected a cut of 100bp, whereas the remaining expected a 50bp cut.
That highlights the extent to which a 150bp cut is not priced into equity markets.
-Methodology change creates confusion- There still remains some confusion regarding the MPS, due to the methodology changes that the SBP has introduced in the monetary policy regime, as per IMF requirements. The SBP has changed its policy rate from the reverse repo rate (ceiling of interest rate corridor) to 50bp below the reverse repo rate. So although the reverse repo rate has been reduced by 1% to 7.0% from 8.0% in this monetary policy, the policy rate is 50bp below that (at 6.5% versus 8.0% previously, a 150bp cut). However, many market participants have misinterpreted this as a 100bp cut (as reverse repo has fallen by 100bp), when it is actually a 150bp cut.
The SBP will maintain the policy rate 50bp below the reverse repo rate through OMO’s.
First the bad news; banking sector battered- The banking sector will bear the brunt of this easing, as 1) the spread between the policy rate and the Minimum Deposit Rate (MDR) has been slashed by 100bp; from 3% previously to 2% now and 2) the level of the policy rate at 6.5% is much lower than expected, which also reduces NIMs. Both these factors will significantly prune CY16 earnings. We estimate that the biggest annualized earnings attrition from these changes will be in BAFL (-18.0%) and HBL (-17.5%).
Least impacted in the banking sector are HMB (-7.4%) and UBL (-8.5%). What is important to highlight is that the narrowing of the MDR-Policy rate spread is permanent in nature, it keeps NIMs suppressed even when interest rates increase again.
-Confluence of positive factors for some- In terms of the stocks that would benefit from this unexpected monetary easing, there are four factors that will drive stock performance; 1) lower finance cost to improve earnings for leveraged companies, 2) demand uptick for cyclical sectors,
3) high dividend yielding stocks become more attractive in a lower interest rate environment, and 4) general re-rating due to lowering of the risk-free rate. Stocks where three or more of these factors are favorable should show strong out-performance in the weeks ahead. In terms of sectors, this implies that Cement, OMC’s, and Autos would outperform.
-Growth revival now the priority- On a macro level, this MPS is the clearest indication yet from the SBP that having achieved macro-economic stability, growth is now the top priority. We believe this would be seen as a very bullish signal for the equity market, and paves the way for much needed infrastructure and power sector investment.