The central bank’s assessment of the changing outlook of Pakistan’s external account and inflationary pressure are likely to be the key drivers of the upcoming monetary policy statement (MPS), scheduled on Mar 15’14. Though showing signs of nascent recovery, the structural anomalies continue to pose a major threat to the progress made. Therefore, we believe the policy makers may exercise caution in the upcoming MPS and maintain the discount rate (DR) at current levels. However, judging by the reduction in the bond yields, the market participants expect the central bank to give higher weightage to growth (a possible 50bps rate cut).
Better forex position: better for inflation & gov’t borrowing
The country’s forex reserves have shown considerable improvement in the recent weeks. From a low of US$7.6bn (SBP reserves US$2.8bn) on Feb 07’14, the reserves have reportedly increased by 25% (SBP: 68%) to stand around US$9.5bn (SBP US$4.8bn) as of Mar 11’14 (The Finance Minister’s Press Conference). The improvement is primarily attributed to US$1.5bn inflows in Pakistan Development Fund (PDF). Subsequently, the PkR has strengthened by a significant 7.1% against the US$ in the last seven trading sessions. The improved PkR‐US$ parity bodes well for future inflation expectation, which has already shown signs of moderation. After initially surging to 10.9% in Nov’13, the consumer price index (CPI) has moderated to 9.18%, 7.91% and 7.93% in Dec’13, Jan’14 and Feb’14, respectively. We expect FY14 average inflation to stand around 8.5%, noticeably lower than the central bank assessment of 10‐11%. Besides, the government’s borrowing from the central bank has also taken a breather, as per the latest numbers. The government borrowing from the SBP has reduced to PkR166bn (Feb 28’14) from PkR587bn a week earlier, a decline of PkR420bn in a week.
Bond yields echoing a rate cut
Improved currency dynamics has been taken positively by the market participants, with yields on the benchmark 10‐years PIBs declining by an approx. 40bps in the last trading session. Furthermore, the yields have reduced by approx. 65bps from the recent high. The reduction in the bond yields indicates increased skewness towards a possible rate cut in the upcoming MPS.
To early for a rate cut, a possibility next time
Though increased possibility of a rate cut has emerged, we see the policy makers to exercise caution in this MPS. Despite improvement in the forex reserves position, our assessment suggests the reserves positions still to be a comfortable level (import cover of 1.4‐months at SBP reserves versus the desired levels of 3‐months). Further, heavy tilt of M2 towards NDA (NDA/NFA ratio at 80.1x) also advocates caution. However, we highlight further strengthening of the forex reserves to make a compelling argument for a rate cut in the next MPS.