Lets start with inflation. Twelve months CPI moving average is down to 2.7 percent and trimmed core inflation dipped to 3.7 percent while the headline inflation was 1.6 percent and trimmed core was 2.8 percent in October. The full year inflation (FY16) is likely to hover around 4 percent while the SBPs target interest rate is at 6 percent and the discount rate is at 6.5 percent.
Thus, seeing from the inflation lens, there is still room of a cut in discount rates which was 10 percent in November last year - an effective cut of 400 bps since has already taken place. However, the easing cycle is yet to prove its efficacy - private credit in fiscal year to date is up by a mere Rs15 billion as compared to Rs45 billion in the corresponding period last year (when discount rate was at 10%).
But that does not imply that there is a need of further easing in monetary policy to spur the private credit as there are other elements which are precluding the credit off take. The banking system is not generating enough to fulfil the requirement of the fiscal financing; leaving nothing for riskier lending to private sector. And any further decline in interest rates may not help until government finds external sources of finances or allowance of direct borrowing from State Bank (note printing). Even, non-banking domestic sources (direct lending to government through PIBs or NSS) are in competition to banking deposits which in turn are routing to government treasuries through banks buying of T-Bills and PIBs.
Hence, the chances of further monetary policy easing to spur private credit are less. Its the federal government that has more stakes in the system and is direct beneficiary of easing as its domestic debt servicing fall. Ironically, market pundits feel that Finance ministry is dictating the monetary policy decisions. Assuming this is true, Dar is the key person driving the decision.
What else is on Dars mind that is more important than interest rates? Yes, you are right, its the exchange rate. The pricing variable that any central bank has to play with are interest rates and exchange rates. If you want currency to appreciate or not let it depreciate, you cannot lower interest rates too much.
This one single most important factor may compel Dar to not lower the discount rate further to stabilize the currency. But knowing the accountants way of thinking, he may find a non-economic way to ease the monetary policy and appreciate the currency as well.
The market sentiments are mixed. A survey conducted by BR Research is favouring status quo - 14 participants out of 19 contacted are of the view that the policy rate will remain unchanged on Saturday while the remaining 5 think that 50 bps cut is in offing. The recent trend in T-bills and PIBs yields suggest that there is some room for easing this time as cut off yields are down by 15-20 bps in recent PIBs auction.
BR Research is of the view that monetary easing is bottoming out and there should be no change in interest rates. Even solely looking at inflation, the decision should be focusing on the future outlook rather than what happened in the past. Inflation has bottomed out as 1.6 percent in October is probably the lowest number in the cycle as the inflation started falling from November 2014 and by virtue of that, base effect would be low from November 2015 onwards to make the headline numbers higher. In November, the headline inflation will be around 2.5-3 percent and it will be around 4 percent In December and more in months ahead.
Thus, its not prudent to lower the interest rates at a time when inflation is heading north. The current account numbers released yesterday show a deficit of $416 million in October as against the commutative deficit of $116 million in the first quarter (Jul-Sep). Higher trade deficit owing to no CSF flow in October and slowdown in home remittances is explaining higher CAD. This implies a cautious stance. But the reserves situation is comfortable as total foreign reserves of the country are hovering around $20 billion and likely to increase further in coming months. Thus, if Dar is convinced that there is still some room left in easing the monetary policy; its the right time as once inflation started heading north; the rationale would not be there. A midway ground for Dar is to keep the discount rates unchanged at 6.5 percent and may lower the target rate by 25-50 bps from existing 6 percent to ease the rates in a way indicating that its the end of easing cycle. But it all depends on how the IMF had advised countrys economic manager in the Dubai moot earlier this month. If the fund has categorically stopped Dar from easing, there will be no change; otherwise he is seemingly inclined to have one last cut in the policy rate.
Source: BR Research MPS Survey
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