State Bank of Pakistan announced a 50bp cut in the Discount Rate to 10% in its Monetary Policy Statement on Friday, October 5, 2012. The central bank’s decision to cut rates was led by (1) consistent and faster-than-expected deceleration in inflation – recall September 2012 CPI hit a 33-month low of 8.79%; and (2) the need to drive private sector credit offtake. To this end, the State Bank also announced liquidity management measures, geared towards encouraging banks’ to lend to the private sector. From the KSE’s vantage point, the rate cut is positive for valuations. We estimate 1-5% upside in valuation for stocks in our JS Universe on account of 50bp lower discount rate. That said; sentiments are a different ball-game. We flag that the rate cut is below expectations where we eyed a 75-100bp rate cut and the market was also preparing for a single digit policy rate. We believe lower than eyed policy rate cut could somewhat dampen market sentiments. That said, with (1) Friday’s concerns on a potential “no-cut” outcome; (2) SBP’s liquidity enhancing measures and (3) cushioned downside for banks’ (20% KSE-100 weight), we could eventually see a relatively soft landing for the KSE.
Soft CPI creates room; private credit offtake goal
State Bank of Pakistan (SBP) announced a 50bp cut in the Discount Rate (DR) to 10% in its Monetary Policy Statement on October 5, 2012. This takes FY-to-date policy rate cut to 200bp, bringing the DR back to levels last seen in January 2008. According to the SBP, its decision to cut rates was led by (1) a consistent deceleration in inflation, the pace of which was faster than SBP eyed and (2) the need to spur credit offtake by private sector to deliver investment-led GDP growth.
SBP dubbed the recent soft CPI numbers (8.79% in September 2012; 9.15% in 1QFY13) as the potential beginning of a broad based trend and cited increased likelihood of the government meeting its 9.5% CPI target for FY13 (JS estimate: 9.3-9.5% for FY13). The SBP also flagged possible ongoing benefit to core inflation on account of retirement of Rs412bn of government borrowings from the SBP in 1QFY13.
Meanwhile the central bank was quick to caution that materialization of the same would largely depend on the government’s resolve to maintain the trend of lowering borrowing from the SBP in the coming quarters as well.
SBP pointing banks’ towards private lending
On the potential of reducing banks’ Minimum Deposit Rate (hiked to 6% in August 2012), the SBP remained mum. The Central Bank did however highlight that banks’ continue to avoid private sector lending and “will have to step up efforts” to revert to their basic role. To this end, the SBP also unveiled certain measures to strengthen the liquidity management framework. The gist of the liquidity measures (detailed below) is to free up banks’ liquidity but at the same time propel this excess liquidity towards the private sector:
1. 100bp lower CRR: SBP has reduced the daily CRR (Cash Reserve Requirement) by 100bp to 3%, however the same has to be maintained at 5% during the reserve maintenance period (every fortnight). The measure is aimed at freeing up banks’ liquidity in order to provide them with room to meet private sector credit needs.
2. Lower Repo rate but penalty for frequent users: SBP has reduced the ceiling of its interest rate corridor by 50bp to 10%. However the SBP has decided to introduce a penal charge of 50bp for banks’ that approach the discount window more than 7 times a quarter. Our understanding on the above is that SBP is looking to discourage the trend of banks’ borrowing from the discount window and subsequently using the funds to invest in government securities. It also underlines the SBP’s focus to push banks to strengthen their own balance sheets rather than rely on recourse to the SBP.
KSE reaction: 50bp a dampener, soft landing eyed
The rate cut is positive from a KSE valuation perspective; where we estimate 1-5% upside in valuation for stocks in our JS Universe on account of 50bp lower discount rate. Sentiments on the other hand, could take a hit. Friday’s rate cut came in below expectations where the market was looking towards a single digit policy rate, in particular after September 2012 inflation clocked in at 8.79%. That said, after initial disappointment, we eye a relatively soft landing for the KSE on the back of (1) better than worse-case scenario given Friday’s concerns/rumours on a potential “no-cut” outcome; (2) SBP’s liquidity enhancing measures and (3) cushioned downside for banks’ (~20% KSE-100 weight), via lower than eyed rate cut and therefore lower eventual spread compression which could drive a relief rally in banks. We also flag that a 50bp cut this time round, does leave some room for future rate cuts on the table. Key to watch in this regard is any softening of core inflation and the IMF’s stance.