April 17, 2020 (MLN): The relentless demand from business and industrial communities to bring interest rate to single digit has been heeded by State Bank of Pakistan in its surprise move yesterday in which the central bank slashed policy rate by further 200 bps to 9% which is almost a 19 month low-level.
This was in addition to the 225bps cut announced last month, bringing the cumulative easing to 425 bps this year as in the last MPC meeting on March 24, 2020, SBP underscored that the committee stood ready to take whatever actions needed in response to the COVID-19 and its ensuing economic impact.
This proactive decision by SBP was hailed by many traders, businessmen and industrialists as it will help highly leveraged companies and people defaulting on loans by reducing markup payments cost and help commercial banks to ward off losses.
The emergency rate cut came on the back of worsening global and domestic economic outlook due to the havoc potentially caused by COVID-19 and improved inflation outlook following a plunge in consumption which has led a broad-based decline in commodity prices. since SBP expects 11-12% average inflation in FY20 and firmly believe that in FY21 inflation will fall back to single digit in the range of 7-9%. Nevertheless, with 11% forward inflation, real interest rates are now zero and remain under SBP comfort zone and in-line with major emerging markets.
The decision also took into account the recent positive developments such as approval of IMF’s USD 1.386 billion emergency financing support to curb the human and economic impact of COVID-19, USD 1 billion from World Bank and USD 800 million along with debt relief to the tune of USD 12 billion from Paris Club and other bilateral creditors. These assistances would ease the stress on the exchange rate as these funds would help in protecting a severe drawdown on the country’s foreign reserves.
Certainly, a significant rate cut amid extremely high uncertainty regarding the severity and duration of the COVID-19 shock would offer much needed economic support and would provide some relief to country’s fiscal space by reducing the governments’ interest expense on existing debt portfolio.
In addition to this, the money market instruments such as PIBs and T-bills, which already reported a decline in their yields as a result of SBP’s decision to cut the policy rate by 225bps in two separate sessions last month, will emerge as the positive game-changer for the country’s equity market as in a scenario of declining interest rate, the equity market will be more attractive for investment relative to these money market instruments.
Alongside positive impacts, the interest rate cut would hurt the companies having exposure to discretionary demand as they may not be able to post strong profitability, a report by Al Habib Capital Market highlights. Furthermore, it will also compress the banks’ margins.
The report further cautioned that in case if the lockdown sustains for a longer period, the situation will be a double whammy for the baking sector as banks have not been as aggressive in accumulating PIBs as they were in last easing cycle. Thus, their margin compression would be more severe as compared to the recent past.
Since the impact of COVID-19 is still undetermined till yet, however, once the lock down period end this rate cut will be beneficiary for the economy.
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