MPS review: Balancing act

December 15, 2021 (MLN): With an aim of getting the balance right to guard against inflation and ensure the longevity of economic growth, the Monetary Policy Committee (MPC) of the central bank yesterday delivered another increase of 100bps policy rate to 9.75%, taking cumulative rate hike to 275bps since September 2021. While signaling that no hike could come as soon as March 2022.

More notably, the State Bank of Pakistan (SBP) communicated that it would likely keep the policy rate “broadly unchanged in the near term”, believing the recent monetary policy actions are sufficient to moderate demand pressures in the coming months and meet mildly positive real interest rates in the medium term- unless future inflation and current account deficit (CAD) data suggest otherwise.

This comes largely in line with the market’s expectations, however, some quarters in the market were expecting an increase of up to 150bps after a significant jump in cut-off yield in the last T-bill auction. Meanwhile, the SBP termed this increase in secondary market yields (jumping more than 200bps since previous MPS) to be “unwarranted,” as it seems to firmly rebuild the credibility of its forward guidance.

As expected, in today’s auction, the yields on three-month treasury bills (T-Bills) stayed at 10.78% and cut-off yields on the sixth and 12- month bills were also unchanged at 11.50% and 11.51%, respectively, The auction target was Rs1.4 trillion, indicating interest rates would hold current levels.  

In light of the recent inflation outturns, the SBP has revised its inflation outlook to 9-11% for FY22 from the previous 7-9% as it continues to soar to 11.5% in November against 8.7% on average in the prior 4mths. However, it is expected that inflationary pressure will fade in the second half of 2022, potentially into the single digits as global commodity prices moderate from recent highs. Not to forget some risks that could push up headline inflation above 11% during CY22 due to IMF stringent conditionalities for EFF (Extended Fund Facility) program resumption that include an increase in petroleum levy which can offset the impact of lower crude oil prices, possible increase in base electricity tariff and the imminent removal of tax exemption.

Moreover, amid the higher international commodities prices, the overall import bill accelerated significantly. The preliminary merchandise trade data for November showed that imports hit a record high of $8 billion, up by 83% YoY. Meanwhile, the domestic currency continues to bear most of the brunt in recent times on the backdrop of dwindling CAD.

Despite improvement in exports and remittances, the external account is expected to remain under pressure with projected CAD to be around 4% of GDP or $13 billion in FY22, higher than initial expectations of 2-3% of GDP as the MPC noted that the monthly deficit will be strong in the near term but possible fall in global commodity prices due to normalization of the supply chain, monetary tightening by other Central Banks and fiscal measures to moderate demand could turn the monthly deficit into a manageable level. Hence, this will ease off the pressure on the rupee against the greenback.

From the stock market perspective, the change in the stance of the central bank from faster adjustments to achieving the goal of mildly positive real interest rates would restore investor confidence, the research note by Foundation Securities said.  However, this may prove to be short-lived given expected fiscal tightening (mini-budget) and the level of interest rates where they are likely to cause a reversal of flows to fixed-income instruments. Moreover, from a valuation perspective, the development is neutral as the market has already priced in the rise in the policy rate, it added.

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Posted on: 2021-12-15T23:37:46+05:00