January 22, 2019 (MLN): The upcoming Pakistan Investment Bonds (PIBs) auction on January 23, 2019 is expected to have strong implications for both, the local equity as well as bond markets, a report by Topline Securities suggests.
After rejecting bids for Oct and Nov, the government in its previous PIB auction dated December 26, 2018 accepted small amount (Rs22.5 billion) with cut off for 3, 5 and 10 years at 12.2%, 12.7% and 13.1%, respectively. Moreover, these cut offs were up by 472bps, 345bps and 442bps higher over the last auction for 3 (13 Jun auction), 5 (6 Sep auction) and 10 (13 Jun auction) year PIBs, respectively.
The PIB cutoffs in December were higher than secondary market rates by 7-44 basis points, which was not only a surprise for the market but also an indication of further monetary tightening. In addition to this, the steepening of yield curve also suggests that market is expecting further monetary tightening.
As per the report, the upcoming PIB auction will witness strong participation from non-banking financial companies like Mutual Funds and insurance companies. Some banks may also now participate given high interest rates while most banks’ participation will come post entry into International Monetary Fund (IMF), as per channel checks.
A substantial amount pick up from banks will lead to restructuring of government’s debt profile, as it has continuously resorted to the State Bank of Pakistan since the end of last IMF program (in October 2016) where borrowing from SBP now stands at ~Rs7 trillion, up from ~Rs5.5 trillion since FY16.
The cumulative borrowing from central bank during the period Jul-18 to Jan-19 stands at Rs.3.45 trillion, whereas it was just Rs.560.4 billion in corresponding period previous year. This goes on to show the large dependence of government on the central bank.
Moreover, the borrowing from central bank and printing of currency is inflationary, therefore, government should switch its borrowing from T-bills to PIBs, as it may not only result in lengthening of government’s debt profile but also help evade re-pricing risk associated with short term debt.
If the banking sector exhibits substantial participation in the upcoming auction, the PIB to Deposit ratio of listed banks may increase from 15% in Sep 2018 to 30% in Dec 2019, which almost equals Rs2.2 trillion of additional PIBs. Moreover, approximately Rs720 billion worth of PIBs are also maturing in 2019, which would take the total PIB participation of Pakistan listed banks to Rs2.9 trillion, the report said
On the back of higher participation in PIBs and other sector dynamics, the earnings of banking sector is expected to grow by 19% (excluding outliers) in 2019 based on NIM expansion to 4.2% (from 3.5% in 2018).
Moreover, higher yields on PIBs will also impact the equity market, most probably leading to a shift of investor preference from equity to fixed income, with required rate of return on equities increasing to 19-20%.
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