Policy rates to remain stagnant, Fitch paints a pretty picture

May 22, 2019 (MLN): With the signing of a $6 billion deal between Pakistan and International Monetary Fund (IMF), the country’s economic predicament took a fresh turn which allowed an impact on the equity market, the key policy rates, and the foreign exchange scenario.

While the majority of economic analysts foresee policy rates to touch new heights and PKR value to sink to deeper pits in the next few months, Fitch Solutions Macro Research believes otherwise as their recently published analytical note injects a certain sense of hope in times of crisis.

IMF’s agreement with Pakistan entailed a 7.45% devaluation of the Pakistani rupee to around PKR 151.92 per USD on May 17, from around PKR 141.39 /USD previously.

In return, this stimulated the central bank to announce a 150 bps increase in its benchmark interest rate to 12.25% on May 20.

According to SBP’s monetary policy statement, the decision was driven by the ‘underlying inflationary pressures from (i) higher recent month-on-month headline and core inflation; (ii) recent exchange rate depreciation; (iii) an elevated fiscal deficit and its increased monetization, and (iv) potential adjustments in utility tariffs ’.

Fitch Solutions writes in their note that the “aggressive pre-emptive hike will help to cool inflationary pressures over the coming months, and will also likely have downside effects on credit growth as well as economic activity.”

Following their expectation for inflation to stabilize in the next few months, the research house forecasts that the State Bank of Pakistan will maintain its benchmark interest rate at 12.25% throughout the rest of 2019.

Analysts at Fitch Solutions believe that the 150 bps interest rate hike will most likely support a stabilization in inflation over the coming months. “In particular, the interest rate hike has brought the real interest rate firmly into positive territory of around 3.5%, which should help to stabilize the rupee and hence prices of imported goods. Higher interest rates and a more stable currency will ease consumer price inflation which has already started to fall slightly to 8.8% YoY in April, from 9.4% YoY in March.”

Although the research house’s oil and gas team forecasts Brent Crude prices to average USD 73/bbl in 2019 (from year-to-date average of around USD6 6/bbl), they believe that the recent hikes will be able to counter the inflationary pressure resulting from rising oil prices.

“Accordingly, we forecast inflation to stabilize to an average of 7% in FY 2019/20 (July-June), slightly higher than SBP’s target of 6.0% for FY20 18 /19, but considerably lower from the 8.8% YoY recorded in April,” says Fitch.

But what creates a ripple of uncertainty in Fitch’s forecast is that a similar prediction was made 4 months back when the State Bank’s monetary policy review was in order, that “given that the central bank hiked the interest rates by a cumulative 425bps to 10.00% in 2018, it is expected that SBP will remain on hold for the remainder of the current financial year 2018-19.”

However, this expectation has long been trampled on and we are currently face to face with a benchmark interest rate of 12.25% for the next two months.

In response to Fitch’s previous prediction, Mr. Saad Hashmi, Economy Expert at Topline Securities had panned out a contradictory view, saying that the interest rates would be raised in future and the inflation would rise as well given the 25% rupee devaluation in 2018, the complete impact of which was still to reflect on inflation, at the time.

Building further on this point of view, the first MTB auction after central bank pushed up the interest rates is scheduled for today, where the auction target is Rs.600 billion against a maturing amount of Rs.500.7 billion.

The SBP received bids worth Rs.3.3 trillion, out of which only Rs.1.5 billion were for 6 months while no bids were made for the 12 month Treasury.

The lack of participation in longer tenors signals the market’s expectation that interest rates will continue to rise in the upcoming months.

Copyright Mettis Link News

Posted on: 2019-05-22T12:56:00+05:00