150bp DR cut: Jubilant KSE, but is it too much too soon?


In a highly awaited move, the State Bank of Pakistan announced a 150bp discount rate cut in its August 10 Monetary Policy Statement, bringing down the policy rate to 10.5%. While the reduction in policy rate should not surprise the KSE, we believe quantum of cut will be received positively at the bourse given that expectations pegged the cut at 50-100bp. We anticipate a positive market reaction in the immediate term, where (1) rate sensitive companies including highly leveraged cements and fertilizers; and (2) yield plays should command the lion’s share of attention while Banks are the likely victims. In the longer term though, we highlight that the key question will be whether this is “too much, too soon” where challenging macro environment is likely to keep market jubilation in check. The State Bank of Pakistan (SBP) announced a 150bp cut in the policy rate in its first Monetary Policy Statement (MPS) of FY13. This is Pakistan’s first rate cut since November 2011 and brings the discount rate down to 10.5% (from 12.0%). The Central Bank noted that the rate cut was made possible by the low inflation reading of 9.6% for July 2012 and a somewhat improved inflation outlook for the ongoing fiscal year. SBP on Friday issued guidance that it now eyes FY13 inflation at a lower than earlier expected 10-11%.

Boosting private sector credit is priority

While highlighting its continued concerns on the economy, the SBP concluded that the need to provide cheaper credit to the private sector and spur investment led growth, drove its decision to slash the discount rate. SBP Governor stated that as a result of softer inflation and sharp decrease in loans to private sector businesses, the real interest rate for the private sector has increased. Hence SBP decided to “give a relatively higher weight to the state of private sector credit and investment in the economy, knowing that the projected inflation for FY13 could remain slightly higher than the target”.

Macro situation dubbed ‘unenviable’…

While the rate cut is a key positive for KSE participants, we believe the key question is whether this is “too much, too soon”, given (1) the admittedly temporary nature of single digit July 2012 inflation reading and (2) risks to the Balance of Payments (BoP) and currency in 2HFY13, once the buffer of CSF flows is exhausted. This will, no doubt, also give rise to some scepticism on potential populist moves against the backdrop of FY13 being an election year. We believe the same should temper the KSE’s reaction in the medium term, suggesting market excitement could be fairly short-lived. The SBP is no stranger to the above mentioned risks, with the SBP Governor once again highlighting:

Government borrowing from SBP & banks: which is limiting the effectiveness of monetary policy. GoP, despite reassurances, borrowed Rs505bn from the central bank and Rs693bn from scheduled banks in FY12. While YTD FY13, GoP has retired Rs206bn of SBP debt, sustaining this trend is key.

Temporary nature of low inflation: as low inflation in July 2012 was heralded by an unanticipated fall in international oil prices in May-June and a 50% reduction in the prices of gas in early July 2012. The former has already proved to be temporary; the effects of the latter may also only have transitory effects for a few months.

Unabated energy shortages: which are both, (1) a risk to both inflation outlook and (2) a key deterrent to private sector investment. As a result, businesses prefer to avoid significant commitments in terms of expansion and long term fixed investments.

Risks to the Balance of Payments in 2HFY13: where SBP flagged that despite cushion from CSF flows and potential 3G auction, the situation remains risky given low export diversification, oil price risk, limited investment inflow to Pakistan and scheduled debt repayment to the IMF.

KSE impact – Cements & fertilizers in sweet spot

While a cut in the policy rate was largely expected by market participants, we believe the KSE-100 is likely to react positively to SBP’s move. Note that the quantum of rate cut announced (150bp) is larger than what the KSE was factoring in where expectations hovered around a 50-100bp cut. We flag that (1) rate sensitive companies, including highly leveraged cements (top pick: DGKC); and fertilizers (top pick: Fatima Fertilizer) and (2) Yield plays like the quasi-bond IPPs (top pick: Hubco) and FFC have the most to gain from Friday’s sharp rate cut. For banks, there is less to cheer. While we see potential valuation upside, we believe earnings risk will arise from the 2-way spread contraction (lower yields coupled with recent hike in minimum saving by 1ppt to 6%). Likewise for cash rich E&P and Autos, we see marginally softer earnings as a result of lower interest income on cash & bank balances.


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