A 50bps cut likely in upcoming MPS

The State Bank of Pakistan (SBP) has scheduled a Monetary Policy Meeting on May 15’20. We anticipate a 50bps cut in interest rates, bringing the policy rate down to 8.50%. As the economic landscape has shifted away from stabilization and moved towards recovery, we believe sustained monetary easing synergizes with the prevalent fiscal stance.

Benign inflationary trends further support our stance

Our stance of a cut is further supported by the recent weakness exhibited by inflationary trends supported in part by low domestic oil prices, causing CPI inflation to slow down to 8.5% as of Apr20 compared with a peak of 14.6% witnessed during Jan20.

Going forward, we anticipate CPI to register around 8.0% during May20 with Ramzan-led food inflation largely offsetting the sharp decline in oil prices. Onwards, we expect inflation to touch 7.3% during Jun20 once food prices normalize post the Eid holidays. Moreover, the SBP continues to maintain its medium-term inflation target of 7%-9%. Overall, we believe the risk of monetary easing instigating inflationary pressures is largely subsided amidst the demand contraction emanating from the pandemic.

Real interest rates on the decline

Real interest rates have come off recently post the recent easing and are hovering around the 0.5% mark as of Apr20. While inflation is expected to come off in the coming months, we believe the SBP will likely opt to keep real-interest rates near the average 2.5% mark to potentially balance the country’s savings rate. Moreover, we believe the SBP will try to avoid excessive easing particularly in view of the recent strength witnessed in global oil prices post the announced production cuts by OPEC countries.

Currency markets faring well in the face of monetary easing

The currency market has also been able to fare relatively well in the face of interest rate cuts. Note that the initial wave of monetary easing and resulting capital outflows (USD 2.5bn since Mar20) from the debt market exerted significant pressure on the Pak Rupee, causing the currency to lose 7% of its value within a span of 14 days. Onwards, the currency found support from IMF’s emergency support funding (USD 1.4bn) and a potential debt relief plan from G20 countries with the Pak Rupee recovering 5% of its lost value so far. While a further cut may exert additional pressure in the currency, we believe the bulk of its impact has largely been weathered since only 20% of the original investment to the debt market remains. Overall, we believe the Pak Rupee may find stability despite a sustained monetary easing cycle.

External trade statistics may be a cause of concern

Pakistan’s external trade figures during Apr20 fully reflected the impact of the coronavirus pandemic. Exports depicted considerable sensitivity to the economic slowdown, registering a decline of 47% MoM to USD 957mn. In comparison, imports exhibited stickiness over the situation and recorded a fall of just 7% MoM to USD 3,088mn during Apr20, causing overall trade imbalances to rise 42% MoM to USD 2,132mn.
We believe further easing may potentially spark concerns over a consumption-led growth in imports, putting additional pressure on the external account imbalances. This fact, in addition to the expected slowdown in remittances (-6% MoM to USD 1,790mn during Apr20) may likely compel the SBP to place a limit on the quantum of easing.

Monetary easing to gel with prevalent fiscal constraints

We believe sustained monetary easing is expected to gel well with the government’s prevalent fiscal constraints particularly the expected decline in tax receipts. Moreover, additional monetary easing will help in flattening the yield curve, increasing overall participation in the longer-term securities. This scenario has the potential to assist the government in re-profiling its outstanding debt towards longer tenures.

The shift in yield curve depicts caution

Short-term yields have gone up by 51bps since the past 2 weeks likely suggesting the recent external trade numbers have compelled market participants to scale-back their expectations of potential easing. The curve, however, still suggests expectations of a 100bps cut during CY20.

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