Twelve months moving average inflation is at 3.6 percent and FY16 full year CPI is expected to be around 5 percent while the policy target rate is at 6.5 percent and the discount rate at 7 percent. The real interest rates are well in the positive territory (1.5-3.4%) regardless of the definition. The raw data tilts towards further easing in the monetary policy to be announced on Saturday.
Twenty respondents were contacted by BR Research yesterday and three fifth are for 50 bps cut while the rest expect no change in the monetary policy. In the last policy review, all the houses were expecting no change and there wasn't any change by the central bank.
What has changed the approach of half the analysts? The market was cautious last time for expected resurgence of inflation due to floods, big hike in utility prices and possible northward movement of oil. However, none of these threats materialized and CPI averaged at 1.8 percent for Jul-August and it may remain below 2 percent for September as well.
The SBP reduced the discount rate by 100 bps in May while in attempt to squeeze interest rate corridor's volatility, introduced target policy rate at 50 bps low (6.5%). The central bank is injecting liquidity at 6.5 percent but the market keeps on assuming 7 percent as policy rate – T-bills yields are around 6.9 percent.
The NFNE 12 month moving average is at 5.9 percent while in August it was 4.1 percent. If the situation is analyzed solely from the lens of inflation, a rate cut is in the offing. But one has to look at the easing cycle and its impact on monetary aggregates – since November, the interest rates are down by 300bps and its impact is ought to be on the demand soon. Empirically, the monetary behaviour change lags by 6-18 months from the rate change. The demand of private credit is sluggish so far. In FY15, credit to private sector flow (Rs208bn) was 56 percent of what it was in FY14 (Rs371bn). In the first two months of FY16, the situation hasn't changed so far – credit to private sector fell by Rs73 billion as against fall of Rs55 billion in the corresponding period last year.
Either the policy rate is irrelevant for credit demand or its impact is yet to be translated. The overall monetary aggregates are expanding as M2 grew by 13.2 percent in FY15 while the nominal GDP growth was 8-9 percent (4% real growth plus 4.5% inflation). This implies there is no problem in money expansion and it may fuel inflation in the months to come. But why the private credit is not growing? The reason is simple. Government is having the lion's share of the pie – government borrowing from scheduled banks was Rs1.3 trillion (more than overall monetary expansion) in FY15 leaving no room for the private credit to grow.
On top of the M2 expansion, the SBP's liquidity injection is over trillion rupees. There is no problem of liquidity in the market; the more important factor than of downward revision in interest rates is to reduce the reliance of government borrowing from the banks.
Hence, the fiscal borrowing is delaying the transmission of monetary easing on the private demand. But the demand is likely to pick up by looking at expansion plans of companies and green field projects of public sector entities.
EPC contracts have been awarded for two mega RLNG projects' of $800 million each and soon they will raise money from the system as for one project there is a local consortium of NBP and HBL. There are other projects on coal in the pipeline as well. A few companies are in expansion mode – three cement companies have already announced expansion plans and a few others are considering the option. There are expansion plans in steel, paperboard and other industries as well. In power sector Hubco, K-Electric and Engro are on new projects to name a few.
The monetary easing and improved macros are reaping fruit and soon investment will start pouring in with its magic of multiplier. The only sector that is cutting a sorry figure is exports – Pakistan exports are down to 8.8 percent of GDP which is the lowest in decades. Something has to be done to fix it and they need a correction in currency market.
The rupee is down by 2 percent last month in pressure of steep fall in currencies of virtually all the competitors. There is more room in its adjustment – the need is to let the currency find its real value. But Dar is too sensitive on currency's depreciation and monetary policy can address the issue by fall in export refinance rates which are currently at 4.5 percent.
Even after doing so, the central bank may have to depreciate currency further and that may increase inflation. CPI is going to be high after November when the base effect will be opposite to what it is today. There is another issue of the fall in banking deposits which could be due to low rates on deposits and the newly imposed tax on banking transactions.
The country's saving rates are too low and depositors ought to have some incentives to keep savings in banks, and further cut in rates will exacerbate the situation. The need is to tread cautiously and do not make the interest rates too low. Status quo is recommended but the vibes are of a 50 bps cut.
Comments
Comments are closed.