Policy rate may dip by 50-100 bps by Dec 2014

With June’s monetary policy announcement due in next few days, the markets in the country are still confused about the State Bank of Pakistan’s expected stance on discount rate. “Much of the prevailing ambiguity is due to low inflation but no clarity on foreign inflows coupled with high budgetary borrowings target set by the new government in FY14,” viewed the analysts at Topline Research.
They believe that it was not the question of whether the interest rate would come down but when and by how much the rate would come down.
The current year’s average inflation now estimated at 7.5pc which is much lower than targeted by the government at 9.5% and SBP’s initial target of 9.1pc.
Further, with Topline forecast of 8-9% inflation in FY14, the central bank is providing an arbitrage like investment opportunity to those who believe that foreign funding through IMF, Saudi Arabia or the US would materialize soon.
“Contingent upon these factors, we expect discount rate to decline by 50-100bps by Dec 2014,” said Topline analyst Zeeshan Afzal.
He said whether the central bank would adopt “wait and see” strategy in June 21’s meeting and provide more time to the investors to make short-term gains at the cost of government would be a subjective judgment of the SBP board.
According to market observers, in country monthly CPI dipped to 5.1% YoY in May which was a 9-year low.
In last three months, average inflation is 5.8% while cumulative CPI has eased to 7.5% in 11MFY13.
On monthly basis, real interest rate has spiked to 4.4%, which has occurred after a gap of 3.5 years. Very few countries in the world would be providing such a high real interest rate.
“Though in FY14, we would see slight increase in inflation due to recent taxation measures in federal budget, expected hike in energy prices and excessive government borrowings but it may not be a restraining factor in monetary easing as we expect CPI to range between 8-9% against government target of 8%,” said Afzal.
The analyst said that as pressures on current account had been eased off due to Coalition Support Fund payment, the Current Account deficit was expected to remain at $2.2bn or 1% of the GDP against FY12’s deficit of $4.7bn that was 2% of GDP.
However, the financing of the deficit coupled with foreign debt repayments had been the issue in FY13.
Resultantly, foreign currency reserve declined to $11.4bn as of June 7, 2013 from $15.3bn in June 2012.
However, the rupee has remained stable during the period and depreciated by 4.2% in FY13TD, 1.5% in 2013TD, versus 10% depreciation in FY12 and 6.2% average annual decline in last 20 years. “In FY14, we think, support to balance of payments and declining forex reserves could emerge from CSF money, Saudi facility or IMF,” said the analyst. The government was also expecting inflow from Etisalat $800mn and privatization. “We feel this may not happen in FY14,” he said. With an arbitrage like opportunity being provided by the SBP, the bankers and investors have participated heavily in longer maturity in last T-bill auction.
This coupled with declining secondary market yields are highlighting the expectation of reduced interest rates by the market participants.
Since last MPS one year T-bill yield in secondary market has declined by 25bps to 9.2% while cut-off yields of 1-year T-bill in last T-bill auction has also declined to 9.28% with about 84% participation in 1-year. However, yields in secondary market have spiked up marginally by 5bps after the announcement of inflationary budget with no concrete sings of foreign inflows yet..