The SBP surprised all by cutting the discount rate by 150bps in the recently announced Monetary Policy Statement (MPS) on October 8, 2011. Contrary to market expectations of a 100-50bps cut, the larger cut which has brought the policy rate down to 12 per cent reflects more of optimism and aggressiveness on behalf of the central bank with regard to the Pakistani economy. More importantly, it indicates an active commitment to play a part in improving the monetary shortfalls that the country has faced for a long period of time. However, how much more is needed is a pertinent question indeed.
The SBP has cited (a) declining inflationary concerns giving rise to the probability of meeting the FY12 inflation targets, and (b) need to support dwindling private sector credit off-take and investment growth as the major comfort points which support its decision. No doubt, these are pretty much correct. CPI in 1QFY12 came in at 11.47 per cent, down from 13.36 per cent a year earlier. Although this contains an element of base year change, easing commodity prices on a global level owing to worldwide recessionary concerns, it helps support a lower view of inflation going forward. Meanwhile, the private sector has experienced a severe crunch in credit over the past year under the high interest environment. Banks seem to be the major culprit in this regard, parking depositor money in high yielding government securities. Advances to Deposits have fallen to dismal levels of 63.5 per cent in August 2011 compared to 72 per cent in the corresponding period last year. Naturally, this was a result of growing NPLs leading to a preference for risk averse avenues; and the interest rates provided the opportunity to access these profitably. Not to say that this does not make perfect business sense as banks have minted massive spreads during the time, each business decision does have its consequences. The private sector unfortunately found themselves on the wrong side of the table in this one.
The move to cut the interest rate is the right one; it’s a need for the economy to be stimulated in a post-IMF donation era. The negatives of the cut – mainly expected depreciation in the currency and pressure on the fiscal budget in terms of revenue sources – clearly fall short of the positives. On this move of SBP, my question is simple; is this interest rate cut enough? The answer to me is a clear no. Leaving aside inflation debates, the objective of supporting private sector credit growth requires more work and further easing. I base this statement on several premises; firstly, the interest rate at 12 per cent is still a high rate, adding on which a 300-400bps spread makes borrowing for a lot of corporate entities an unattractive feature. This is because there is a clear dearth of investment opportunities for companies to invest in. Industries continue to be plagued by infrastructural issues which put a huge question mark when deliberating on new projects. There are corporations which support a bullish stance on the economy and have utilised leverage to fund expansions but have not met with the outstanding success that they envisioned. Case in point being Engro, whose new urea plant although making more than enough business sense as far as demand dynamics were concerned met with deep trouble owing to supply issues. Such infrastructural issues will still be a hindrance till addressed. Yes there will be more calls for funding working capital requirements, but apart from these, it’s hard to think of investment avenues from where demand for credit is going to arise.
Secondly, even if we assume that credit demand does rise as investment opportunities are found, there also remains a possibility that banks would not extend the same still. Banks still have room to absorb a lower quantum of asset yields by maneuvering their cost of deposits either through lowering the rates offered on fixed deposits or through enhancing their CASA ratios. This is a plausible argument; banks have been offering rates of around 8-9 per cent on time deposits and can easily lower the same to maintain spreads. One may think that lowering these would lead to higher competition for deposit. Maybe amongst smaller banks but clearly not for larger banks, which ‘bank’ on their extensive network to retain deposit. In my view, further cuts are required which would drive the policy rate down to a level where it impacts banking spreads forcing financial institutions to look towards advances again. This level would certainly be a single digit figure. The interest rate cut is certainly a move in the right direction towards achieving economic stimulation. It comes as a breather for the current industry and indirectly also provides hope for the future. However, the journey is not even half through and more headway needs to be made if the objectives of SBP are to be truly met.
The writer is a financial analyst with Pakistan Credit Rating Agency (PACRA)
