There is some stability attained on the macroeconomic front in the last year or so. The SBP liquid reserves touched its low at $2.8 billion in Feb 2014, and the foreign flows pouring in since then has taken the reserves at $12.5 billion now - covering 3.6 months of imports.
Inflation, which was in double digits for almost five consecutive years (FY08-12), is expected to be below 5 percent in FY15. The current account is down from high deficit (ranging 2-8 percent in FY06-12) to around one percent in the last two years. And this year is even better as for last two quarters its showing surplus. Fiscal deficit was at 8 percent not long ago and now its coming around 5 percent.
The direction is right despite the fact that structural reforms are yet to be implemented and energy gap still remained high. That is why not every variable is moving in the right direction. There is not much too jubilation on the growth indicators: GDP growth is still below 5 percent for consecutive seventh year; investment to GDP ratio is not picking up; foreign direct investment is drying up and gross capital formation is abysmally low. Thus, employment generation for incremental 2 million youth coming to working age remains low too.
The economy needs stimulus to move from stabilization phase to era of accelerating growth. The utmost need is to bridge in the energy gap and provisioning of it at affordable prices. The government is cognizant of the fact and is working on it. Though a bit late, there are chances of having additional 7000-10,000 MW by 2018. With low oil prices, tariffs will remain relatively low as well.
Then the CPEC is deemed to be a game changer. About $3-4 billion of FDI is expected to flow in from China for power and other infrastructure projects in FY16. This will make the balance of payment picture even better along with boosting confidence in the domestic economy. The government needs to realise that it should not compromise on development spending; according to a study, the private sector matches the government spending on development immediately.
But that is not enough. The private sector credit has to pick up; its very low now (FY15 to date: Rs162 bn). It has remained subdued since the 2007-08 crises; it picked up a bit last year but its back to southward journey again. One reason to have stabilization in the economy, the government has totally moved from central bank borrowing to commercial banks in FY15, under the conditions of IMF. That has squeezed the room for private sector.
Plus, the hawkish monetary stance in the previous two years has tightened the monetary demand. Its time for doves to dominate and design policies to accelerate growth. The monetary policy is already in easing mode with 200 bps cut in last three reviews; yet the real interest are 3-4 percent which is the highest since the 2002-4 period.
Its likely to cut further by 50-100 bps on Saturday. The market thinks SBP will ease by 50 bps to take discount rate at 7.5 percent. According to a survey conducted by BR Research, 16 out of 20 houses expect a 50 bps cut while the rest are expecting 100 bps cut.
The market consensus is in favour of 50 bps cut in the upcoming monetary policy. Soft inflation numbers and improving external indicators are their primary considerations. They feel that a 100 bps cut seems unlikely as inflation might surge in coming months considering the Ramadan effect, expected rise in indirect taxes and levies in the upcoming budget, oil price rebound and rise in gas tariffs. And given the IMF programme, opting for a conservation approach would be a safer bet. One participant also highlighted the decline in yields in the last t-bill auction where the highest cut was of 44bps, thereby giving an indication of the likely scenario of 50 bps cut in this MPS.
According to our survey respondents, the government has the leverage to cut 100bps considering the current inflation numbers, real interest rates are also somewhere around 450-500 bps. And hence a cut of 100 bps won't come as a surprise. Market yields, too, are suggesting a cut of 100bps. Forex reserves are expected to improve further with the issuance of Sukuk. Besides, lower rates would help the government to raise funding at lower rates for its infrastructural and other projects.
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