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MPS Review: A recipe for recovery?

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March 18, 2020 (MLN): The State Bank of Pakistan has decided to shift its long-held stance on monetary policy by reducing the policy rate which was much awaited.  The central bank cut interest rate by 75 basis points to 12.50 % on Tuesday- the first-rate cut after four years i.e. since May 2016, to support the country's fragile economy, which now faces the threat of the Coronavirus.

The recent attempt to counter the slowdown in economy by SBP follows aggressive emergency rate cuts by its counterparts amid coronavirus pandemic which has shaken the financial markets. However, with no surprise, this move by SBP failed to bring the spirit in the market which expected a bigger reduction on an account of steep fall in long term bond yields and significant outperformance by cyclical stocks, highlighted by Ismail Iqbal’s research.

But finally, the central bank conceded to the fact that the economy needed lower interest rates to stimulate domestic spending and to help lessen the expected initial disappointing response from the equity market.

The decision to cut the rate reflected the improvement in prospective inflation in the light of normalized food prices, a significant decline in consumer price expectations, a sharp fall in global oil prices, and a slowdown in external and domestic demand due to the coronavirus pandemic.

Regarding the underlying inflation trend, the monetary policy committee ( MPC) noted that with the reduced policy rate, real interest rates are “appropriate” to achieve the medium-term inflation target of 5%-7%. There is a likelihood that the average inflation will remain within the SBP’s forecast of 11-12% in FY20. 

According to the research note by Intermarket securities, State Bank drew attention to the effective reserves buffer of more than the $10 billion that could survive such outflow and exchange rates fluctuations on the threat of foreign outflows from government securities due to global risk-off sentiment, Importantly, the State Bank also remarked that it estimates the positive effects of lower oil prices to offset trimmed exports and remittances, even in the long-run case of the Coronavirus outbreak.

The SBP in the MPS  also decided ‘to make the interest rate corridor symmetric around the policy rate, in line with the international best practices which will result in Minimum Deposit Rate (MDR) to decline by 0.25% to11.0%, on the other hand, the lending rate will come down by 0.75% as per research note by Topline.

On the fiscal front, SBP warned that the government could face challenges in achieving revenue targets for this year, especially if there are disruptions in economic activity, and may require additional costs in health and social sectors to cushion the impacts of the Coronavirus pandemic, revealed the research of Al Habib Capital.

The rate cut will benefit the highly leveraged sectors like Cement, Steel, Textile, Chemicals as low-interest rates will allow companies to increase their bottom-line on the back of a reduction in financial charges, along with improved revenues as demand kicks off due to low cost of borrowing for consumers, underlined by Spectrum research.

On the other hand, the rate cut will squeeze the banks’ margins. According to the SBP, banks’ margins are already high enough to absorb the modest compression.

Along with interest rate cut, SBP has announced an Rs100bn “Temporary Economic Refinance Facility (TERF)” and its Shariah-compliant version to stimulate new investment in manufacturing at a maximum end-user rate of 7% for 10 years. TERF will help to counter any possible delays in the setting up of new projects that inventors were planning prior to the Corona outbreak, highlighted by Foundation research.

Keeping in view the recent coronavirus outbreak, SBP announced a “Refinance Facility for Combating COVID-19 (RFCC)” and its Shariah-compliant version of Rs5bn, with a maximum limit of Rs200mn per hospital or medical facility as per the research of Next Capital.

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Posted on: 2020-03-18T16:22:00+05:00

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