SBP may cut policy rates further, banks’ earnings could hurt in 2016

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Owing to the continuously declining inflation, there is a strong chance of further reduction in policy rates by 50 basis points to 5.5 per cent while positive real rates will be close to 2 per cent for 2015-16.

The State Bank of Pakistan (SBP) is expected to announce its monetary policy at the end of this month and can further revise down its inflation estimate for 2015-16, which is currently at 3.5-4.5 per cent.

If the central bank further reduces discount rates, the profitability of the banking sector will be affected by a minor 0.2 per cent in 2016 due to some cushion from fixed income Pakistan investment bonds (PIBs) and treasury bills.

However, experts believe that earnings of the banking sector may decrease by 5-10 per cent. Banks including MCB Bank Limited, Allied Bank Limited (ABL) and United Bank Limited (UBL) will be least affected with an impact of 3-9 per cent.

“Already, secondary market yields of T-bills and government bonds have come down by 20-30 basis points since the start of January 2016, which further strengthens the element of surprise in December’s inflation forecast and chances of further rate cut,” said Umair Naseer, analyst at Topline brokerage house.

Inflation for December 2015 is significantly below expectations at 3.2 per cent compared to estimates of 4 per cent for the month, he said. Because of the lower inflation in last six month, market experts believe that inflation for the full year (2015-16) may not exceeding 5 per cent compared to previous peak estimate of 6 per cent.

International Monetary Fund (IMF) in its latest review reduced the inflation projection from 4.7 per cent to 3.7 per cent for the year. However, these inflation numbers were likely finalised before December 2015, which means that they could be revised down further in future reviews.

The analyst also forecast full year inflation to average in the range of 3.5-4.0 per cent as a consequence of the falling international oil prices. The oil prices came down by 48 per cent during first half 2015-16.

The government has reduced local diesel prices by 6.4 per cent in the last six months, which in turn has reduced inland transportation costs, further softening the prices of local produce. Even though diesel/petrol accounts for 3 per cent of inflation, local produce like potatoes, tomatoes, onions, fresh vegetables, flour, meat, chicken, eggs etc account for 50 per cent of the food items and 15 per cent of the index.

Despite an expected cut in interest rates, the banking sector is performing well at the stock exchange. In 2016 to date, banks currently offered average dividend yield of 8 per cent, higher than the prevailing 12 month T-bill rate of 6.19 per cent.

“The banking sector is also likely to remain a major beneficiary of improving macros and expected increase in credit demand with the implementation of China-Pakistan Economic Corridor (CPEC) projects,” Naseer told Pakistan Today. Credit growth of 14 per cent is expected during the next three years compared to last three years average of 8 per cent, he added.

He said that UBL and MCB, due to attractive valuations and strong fundamentals, will perform well in future. Habib Bank Limited (HBL) could also be a major beneficiary of credit growth led by CPEC projects.

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