June 26, 2020 (MLN): In a surprise move on Thursday i.e. June 25, 2020, the Monetary Policy Committee (MPC) of the central bank decided to slash policy rate by further 100 bps to 7%.
This was the fifth time the SBP has cut policy rate since March 2020, as the economy has faltered under the effects of Covid-19 pandemic, with economic activity ending, instigating the SBP to cut rate by 625 bps from a rate of 13.25% three months ago.
In its last MPC meeting, SBP indicated that inflation is no more a concern as it believes that inflation outlook has improved further while the slowdown in the economy amid the pandemic would have negative implications for growth. This has directed the SBP to shift its policy focus towards the growth revival, securing employment, increase in the consumer spending and support to households.
The SBP believes average inflation can fall below the previously announced range of 7%-9% for the next fiscal year given absence of demand-side pressures, however, there is an upside risk due to supply shocks but SBP views them as temporary due to weak domestic demand. In addition, recently announced Budget is Neutral for inflation because of freeze on government salaries, absence of new taxes and lower production cost from reduced import duties, a report by Topline Securities stated.
Woefully, the downside risks to growth have increased, as the World Economic Outlook (WEO) that was released yesterday, where IMF downgraded its 2020 global growth forecast further to -4.9% and projected a more gradual recovery than previously anticipated.
To make this fathomable why SBP opted for further rate cut, the report underlines “there is approximately Rs 3.3 trillion worth of loans due to be repriced by early July 2020, which is why SBP feels it is an ideal moment to take action from a monetary policy transmission perspective, as the reduction will immediately help reprice loans lower.”
Who is going to reap the most benefit?
Corporates that carry large debt on their balance sheet are likely to witness positive impact on their bottom-line, as higher financial leverage positions will become subject to decline in financial charges.
Similarly, higher consumption on consumer side can result in higher volumetric sales to the companies, a report by Aba Ali Habib Securities highlighted.
Another report by Arif Habib Limited says that DGKC, MLCF, FFBL, PSO and PSMC to be the major beneficiaries given the higher quantum of debt in their capital structure. Moreover, companies with high dividend yield may also become lucrative in the declining interest rate scenario amid higher appeal as compared to return on bank deposits.
On the equity side, the unexpected rate cut by the SBP comes as positive surprise, which could lead to a near-term bull run at the stock market, however, Intermarket Securities believes this may not morph into a sustainable rally in the absence of more assurances on the overall health of the economy, and some semblance of growth among the cyclical sectors in particular. To recall, 525bps earlier cuts in the policy rate were offset by the steep rise in Covid-19 cases in Pakistan and excluding a few sectors, a worsening outlook for corporate earnings growth in FY21.
On the sector front, cement sector, steel and textile to be the main beneficiary; similarly, the fertilizer, chemical and household appliance sector will also have positive impact on their earnings. However, banks are expected to be most affected by this move.
ABA Ali Habib Securities is of the view that the magnitude of rate cut by central bank in last two months has been more aggressive than expected, which coupled with lower non-funded income flows due to subdued trade activity in wake of coronavirus pandemic will dent Banking sector profitability in CY20.
Has the easing cycle hit the brakes?
A report by Aba Ali Habib Securities underlines that contrary to the previous MPC statements, where it notifies of the committee’s focus and intention “to stand ready to take appropriate actions as the need may arise”, the recent statement takes less dovish and more optimistic approach. Statement does not provide clear signal of any further readiness; however, it does highlight the future course of MPC decision to be data driven and growth focused.
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