In its emergency meeting held today, the Monetary Policy Committee (MPC) cut interest rates by an additional 200bps to 9.0%, taking the cumulative reduction to 425bps since the past month. The expedited pace of monetary easing has overshot our original estimates whereby we projected a 100bps cut by May20. In light of the anticipated contraction in the economy post the outbreak, the SBP likely opted for a proactive approach to mitigate its impact and counteract the slowdown. Key highlights of the Monetary Policy Statement (MPS) are:
Global and domestic outlook has further deteriorated since the last MPC meeting. As per projections released this week by the IMF, the world economy is expected to contract by 3 percent in 2020, sharpest since the great depression. As a reference point highlighting the severity of the present crisis, the global economy contacted by 0.07 percent during the global financial crisis in 2009.
Global oil prices have declined further, with futures markets suggesting low prices will persist. In the domestic economy, high-frequency indicators of activity―including retail sales, credit card spending, cement production, export orders, tax collections, and mobility data from Google’s Community Mobility Reports―suggest a significant slowdown in most parts of the economy in recent weeks.
Inflation has witnessed a marked slowdown since the past month evidenced by both a reduction in CPI (10.24% during Mar20 vs. 14.56% during Jan20) and a reduction in SPI (-2.65% since 20th March’20).
As per the SBP, Pakistan’s economy is expected to contract by 1.5 percent in FY20 before recovering to around 2 percent growth in FY21. Inflation is expected to be close to 11-12 percent this fiscal year, and to fall to 7-9 percent range next fiscal year.
Headline inflation may rise in case of temporary supply disruptions or food price shocks, but is unlikely to generate strong second-round effects due to the weakness of the economy. Moreover, the inflationary impact of the recent exchange rate depreciation is expected to be contained given low import demand and falling global prices.
This cut in interest rates may pull real interest rates into the negative territory as SBP has kept its medium term inflation outlook to 7%-9%.
The MPC was of the view that this action would cushion the impact of the Coronavirus shock on growth and employment, ease borrowing costs and the debt service burden and maintaining financial stability. It would also help ensure that economic activity is better placed to recover when the pandemic subsides.
This cut in discount rates could further add to the downside pressure on the Pak Rupee. Note that the PKR depreciated by ~7% during the past 5 weeks the previous reductions, which might have precipitated in net foreign outflow of USD 1.8bn from Pakistan’s debt market during Mar20. While investments of only USD 0.83bn remain from the original USD 3.50bn, we believe the Pak Rupee may maintain its downward trajectory over the medium term.
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.
KASB Research
