-Amidst mixed opinions, State Bank of Pakistan (SBP) kept the Policy Rate unchanged at 10.0% in its Monetary Policy Statement (MPS) on January 17, 2014, on account of (1) lower-than-expected increase in inflation; (2) initiation of fiscal consolidation efforts and (3) a nascent recovery in private sector credit demand.
–Given the glimmer of doubt led by the IMF’s somewhat stern guidance to SBP (released earlier this month) to use “every policy tool at its disposal to boost reserves, including adjusting the policy rate”, we expect the KSE-100 to modestly cheer the outcome of Friday’s MPS announcement.
-That said, we see SBP’s status quo decision as more of a stop-gap than a ringing endorsement given that external account stress is still high and there remains a question mark on the exact timing of improvement (expected to led by foreign financial inflows).
-Resultantly, soft January 2014 inflation outlook notwithstanding (JS Jan-14 CPI outlook: 7.8%), we maintain our stance of a further 100bp hike in the policy rate (to the 11.0% mark) by June 2014.
SBP maintains rate in Jan-14 citing nascent recovery
Amidst divergent opinions (JS expectation: 50bp rate hike), State Bank of Pakistan (SBP) elected to keep the Policy Rate unchanged at 10.0% in its Monetary Policy Statement (MPS) on January 17, 2014, citing:
1) Lower-than-earlier-expected increase in inflation: where 1HFY14 inflation clocked in at 8.9% while we estimate that continued decline in perishable food prices in January 2014 could bring down inflation for the month as low as 7.8% after a FY-to-date peak of 10.9% in November 2013. SBP also flagged a relatively low risk of demand-driven inflation (given sluggish economic activity) in its January 2014 CPI but maintained its FY14E inflation outlook at 10-11% on the back of expected delayed impact of fiscal adjustments.
2) Initiation of fiscal consolidation efforts: which include increasing the rate of General Sales Tax (GST) in FY14 Budget; recent substantial hike in electricity tariffs across the board and withdrawal of certain tax exemptions.
3) Nascent recovery in private sector credit demand: which SBP attributed to additional room created by the partial settlement of circular debt (in June 2013) and the follow through impact of earlier rate cuts by the SBP (300bp reduction in the policy rate in FY13). Note that in 5MFY14, loans to the private sector clocked in at Rs161bn (vs. just Rs16bn in the corresponding period last year) of which Rs38bn went into fixed investment.
KSE-100 perspective: Ringing endorsement or a stop-gap?
While opinions in the run-up to the MPS were fairly divided (expectations spanned the spectrum from a rate hike on account of stern words from the IMF to a rate cut given low Dec-Jan inflation outlook), we believe majority of the equity market was anticipating no-change in rates in the January 2014 MPS. That said, given the glimmer of doubt led by the IMF’s guidance to SBP (in its December 2013 LoI made public in January 2014 IMF staff appraisal said that “In the coming months, the SBP must unhesitatingly use every policy tool at its disposal to boost reserves, including adjusting the policy rate, intervening to purchase reserves on the spot market, and allowing greater flexibility of the exchange rate”), the KSE-100 is likely to modestly cheer the outcome of Friday’s MPS.
While SBP endorsed recent improvements in macroeconomic growth and attempts to reign in the fiscal deficit, the central bank’s tone on the external front was more guarded. While the State Bank acknowledged that external account stress “could recede gradually” on the back of financial inflows and declining debt repayments to the IMF in coming quarters, the SBP was also quick to flag the lack of “room for complacency” as well as the “uncertainty surrounding expected foreign inflows”. The latter include the oft-cited (1) US$800mn pending dues from Etisalat on account of PTCL privatization; (2) proceeds from Eurobond issue; (3) flows from IFIs and other countries; (4) the 3G spectrum auction and (5) proceeds from the government’s upcoming privatization program. Progress on these, in our view, will be key to track in 2HFY14 as they will play a critical role in meeting IMF’s FX reserve target for the March 2014 review as well as on the PKR exchange rate. With uncertainty on the timing of the above-mentioned view and our view of a gradual incline in inflation (soft January 2014 notwithstanding), we maintain our stance of a further 100bp hike in the policy rate (to the 11.0% mark) by June 2014.