The Central Bank’s Monetary Policy Committee with convene on Friday, Mar19’21 to set interest rates for the next two months. We anticipate the Central Bank to opt for a status quo and keep interest rates unchanged at 7.0%.
Our stance is predicated on: 1) SBP’s near-term guidance in the previous Monetary Policy Statement (MPS) of an unchanged monetary stance, 2) relatively controlled external accounts with a current account surplus of USD 912mn during 7MFY21 against a deficit of USD 2,544mn during SPLY, 3) stable reserves position north of USD 20.0bn with expectations of additional inflows from lending agencies, and 4) a possible 3rd wave of the COVID-19 pandemic, potentially dampening the recent economic recovery.
SBP’s unprecedented guidance
In an unexpected move in the last Monetary Policy, the Central Bank offered guidance over the projected trend of interest rates, conveying potential for a near-term unchanged monetary stance. The purpose of the guidance was likely to instill confidence into the economy in light of the uncertain economic environment led by the COVID-19 pandemic. We believe there is a high likelihood that the SBP will follow through with its guidance to uphold the recent phase of economic recovery.
External accounts largely under control
Pakistan’s external accounts have largely been under control since the onset of FY21, recording a current account surplus of USD 912mn during 7MFY21 against a deficit of USD 2,544mn SPLY. This fact, in tandem with bilateral inflows from lending agencies and allied countries, has allowed Pakistan’s foreign exchange reserves to cross USD 20.0bn. Consequently, we believe the SBP will find comfort in keeping interest rates accommodative without the risk of overheating the economic and inducing unsustainable growth.
3rd wave of the pandemic likely under way
Signs of the 3rd COVID-19 wave in Pakistan are apparent with daily infections crossing the 2,500 mark since the 2nd week of March. In contrast, daily infections hovered around the 1,200 mark during Feb21. In light of the proliferating infection rates, likely led by the infectious ‘UK Strain’, NCOC has re-imposed ‘smart lockdowns’ in high concentration areas to prevent the spread. A larger-scale lockdown may be a possibility if infection rates continue to climb further, likely putting a dent on the recent economic momentum. This uncertain economic climate will likely compel the SBP to maintain prevalent interest rates.
Factors in favor of an earlier than anticipated hike
We believe there are certain factors that instigate a divided opinion on the timing of the eventual monetary tightening. These factors include: 1) projected hike in inflationary pressures and 2) increasing stress on external accounts.
Inflationary pressures to pick pace as the IMF program resumes
Inflation has picked pace led by food inflation and rising global oil prices. CPI inflation touched 8.70% in Feb21 and is projected to inch towards double-digits in the coming months. The resumption of the IMF program has caused electricity tariffs to pick up sharply (+30% M/M) with expectations of a gas tariff hike onwards. The IMF program has also compelled the government to withdraw tax exemptions, a move expected to further fuel inflationary pressures.
Also note that present domestic petroleum prices do not fully reflect global oil prices as the incumbent government has decided to reduce PDL (PKR 9.70/sh as of Mar 16’21 vs. the maximum allowance of PKR 30.0/sh) to keep a check on prevalent inflation. With the IMF program focusing on enhancing tax collection, a sharp rise in domestic oil prices is a likely scenario as PDL is increased, further pushing inflationary pressures. In view of SBP’s historical precedent of managing real interest rates, an earlier than anticipated hike may be a possibility if inflation outstrips SBP’s projections (7.0%-9.0%).
Pressure on external accounts to begin mounting as economy recovers
With the economy depicting a sharp recovery (LSM index reaching all-time high levels in Jan21) amidst a low interest rate environment, we anticipate a sharp recovery in consumption-driven imports for the remainder of FY21. As SBP’s TERF financing inches towards PKR 500bn, the import of machinery is projected to pick pace as well. Moreover, the increase in global oil prices is further expected to add to the country’s import bill. These factors will likely exert pressure on the economy’s external accounts, evidenced by the recent 2 months depicting a current account deficit of USD 891mn. Consequently, a fast-tracked monetary tightening may be implemented to alleviate potential external account imbalances.
Monetary tightening likely from FY22 onwards as SBP prioritizes recovery
We believe the SBP will likely opt for a balanced approached and keep interest rates unchanged till the onset of FY22. The economic uncertainty driven by the COVID-19 pandemic will likely compel the SBP to prioritize recovery and uphold the recent trend of the economy’s momentum. We believe interest rates will likely cap at 8.5% in CY21 as SBP’s guidance suggested gradual adjustments to the policy rate to ensure ‘mildly positive’ real interest rates.