Monetary Policy: 50 or 100bps reduction? (PDF Attached) (Jan 14, 2015) No one is asking whether or not interest rate will be cut in the upcoming Monetary Policy meeting. The question is how much cut the SBP board will announce. With 44% fall in global oil prices in last 6 months and considering Pakistan being a net oil importer, CPI inflation is coming down. And that is why the upcoming policy decision and SBP comments are being anxiously awaited. Below is our brief analysis on the possible outcome of Monetary Policy Statement (MPS). 50bps cut expected now, more cuts later With policy meeting after every 2 months, we think, probability is high that SBP will follow a gradual policy of reducing benchmark interest rate because it is difficult to forecast the global price of oil after a sudden fall. Moreover, with Government losing revenues as oil and energy are major contributors to Government taxes, SBP may be cautious that Government may raise taxes (as they did recently by imposing additional 5% GST on oil) thereby diluting the affect of lower oil price on inflation to a certain extent. In terms of macroeconomic recovery and the agreed targets with IMF, Government is largely on track. However, lower revenues on oil products and increased spending on law & order situation could lead to higher fiscal deficit. Government had set a fiscal deficit target of 4.9% for FY15 which is likely to be missed due to above mentioned reasons. An expected slippage on fiscal deficit target could also be one reason why SBP would opt for a cautious approach. Hence, we anticipate SBP to cut the policy rate by 50bps in upcoming MPS and go for a further cut of 50bps later on. Money market expecting 100bps cut Money market is anticipating a 100bps cut in upcoming MPS as yields on government securities have declined significantly by 124-280bps in 4Q2014. Currently, 2-year PIB is trading at 9.0% which is down by 280bps, whereas yields on 6mo T-bills have declined by 124bps to 8.7% in 4Q2014. Inflation to reach 11 year low of 6.0% in FY15 Lower commodity prices and stable food supply in the country has significantly improved the inflation outlook of the country. Hence, we expect inflation to average 6.0%YoY in FY15, significantly lower than Government’s target inflation of 8.0% and last year inflation average of 8.6%. Real interest have also increased significantly due to widening gap between interest rates and inflation. In Dec 2014, real interest surged to 5.2% while 1HFY15 real interest rate averaged at of 3.7%. Since this rate is significantly higher than the historical average of ~2%, downward adjustment in interest rate makes sense. External account is fairly stable External account scenario has also been very stable lately. Total foreign exchange reserves of the country currently stand at US$15.2bn, whereas the reserves held by SBP are over US$10.3bn (equivalent to 3 months import cover). As a result, rupee has been pretty stable recently. In 2014, it has appreciated by 5% against US$ due to increasing foreign inflows. Improved external sector outlook could be another key trigger for a likely rate cut.
Posted on: Thu, 15 Jan 2015 07:48:36 +0000
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