In its meeting held today, the Monetary Policy Committee (MPC) cut interest rates by an additional 100bps to 7.0%, taking the cumulative reduction to 625bps since the past
three months. The expedited pace of monetary easing has overshot our original estimates whereby we projected a 50 to 75 bps cut by year end 2020. In light of the anticipated contraction in the economy post the outbreak, the SBP has prioritized economic recovery and growth amid benign inflation outlook. Key highlights of the Monetary Policy Statement (MPS) are:
To support households and businesses through COVID19 crises, a prompt response was required to curtail downside risk to growth and minimize the damage to the economy. SBP took prompt action to pass on the impact to household and consumers in a timely manner.
COVID19 is spreading rapidly in the emerging markets including Pakistan. The
downside risks to global growth are very high and path to recovery is still uncertain.
IMF has further reduced global growth forecast to -4.9%, 1.9% lower than the April’s
forecast.
Inflation is expected to remain under control going forward. Recent decline in SPI
suggests further drop in inflation in month of June due to overall reduction in price
levels despite increase in food prices, notably wheat. Budget 20/21 is expected to
have no major impact on inflation given decline in subsidies to some sectors will be
offset by freeze on government salaries, absence of new taxes and reduced import
duties.
MPC expects inflation to fall below the previously announced range of 7-9percent
given weak demand. With current reduction in policy rate of 100bps to 7%, the real
interest rates on a forward looking basis are close to zero, and deemed it suitable in
the current circumstances.
High-frequency indicators of activity such as cement dispatches, automobile sales,
food and textile exports, and POL sales also continued to contract in May, although
mostly at a lower rate than in the previous two months. Looking ahead, the economy
is expected to recover gradually in FY21, supported by easing lockdowns, supportive
macroeconomic policies and a pick-up in global growth. However, the pace of
recovery will depend on evolving situation of pandemic both in Pakistan and abroad.
Current account balance turned in to surplus for the month of May due to reduction
in trade deficit and uptick in remittances on M/M. portfolio investment outflows
slowed down in May compared to last two month. FDI remained resilient and almost
doubled to USD2.4bn in FY20.
SBP reserves declined to US$ 9.96 billion as of 19th June 2020 largely due to debt
repayments. However, since then, SBP has received fresh disbursements from
multilateral agencies including $725 million from The World Bank and $500 million
from ADB, and another $500 million is expected shortly from the Asian Infrastructure
Investment Bank (AIIB).
Flexible exchange rate regime played as shock absorber and cushioned the economy
from tightening of fiscal conditions associated with capital outflows from EM. PKR
depreciation has been lower than in many other emerging markets, reflecting the
increased reserve buffers accumulated over the last year. Current account deficit
should remain bounded through the Covid-19 crisis due to lower oil prices. In
addition, projected official and private inflows are expected to keep the external
position fully funded.
We believe this cut will bode well for cyclical industries such as cements, steels, and automobiles, all of which may benefit from the eventual resumption of economic activity in the post-outbreak period. Moreover, leveraged sectors such as textiles, OMCs, in addition to steels and cements, will benefit from a reduction in financial charges. Furthermore, we believe yield plays such as IPPs and Fertilizers may garner attention as reduced interest rates increase the overall attractiveness of their dividend yields. The tables below highlight the overall impact on profitability during FY21 in view of the cumulative 625bps cut in interest rates.
