SBP has room to reduce policy rate by 600bps in FY25: JP Morgan

July 26, 2024 (MLN): Stronger external stability that comes with an International Monetary Fund's (IMF) Extended Fund Arrangement (EFF) removes a key obstacle for the central bank to resume policy easing, JPMorgan's analysts wrote in a research report.

The report noted that periodic energy price adjustments and rate-based taxation measures (i.e., higher sales and excise taxes) should not materially affect the disinflation trend due to offsetting drags from a weaker domestic demand.

JP Morgan expects headline CPI to moderate from 23.9% in FY24 to 9.5% in FY25.

JP Morgan’s Taylor Rule model shows that there is substantial room for easing. As such, we expect the SBP to deliver at least 500-600bp of rate cuts in FY25, with potentially a front-loaded easing profile in H1 FY25 while external conditions remain benign.

After over two years of uncertainty, the EFF program is a timely and material boost to Pakistan’s external debt repayment ability, the report noted.

“We expect further accumulation in foreign reserves, from $9 billion to $15bn in the next 12 months,” it added.

This is supported by the normalization of official creditor inflows, even as the current account (CA) deficit widens slightly, and Pakistan stays on the sidelines of the offshore bond market.

The key assumption here is that the EFF program will unlock financing from major bilateral and multilateral partners, which make up almost 80% of Pakistan’s external debt stock, it said.

“We think this is likely, as unlike the 9-month SBA program, the EFF is a flagship IMF program that represents, at least optically, is a bigger show of confidence on Pakistan’s sovereign credit profile, taking into consideration various factors (e.g., government stability, reform progress, debt sustainability), notwithstanding downside risks,” it highlighted.

Indeed, major multilateral agencies such as World Bank and ADB have recently announced policy-based loans, the report said.

The EFF program, if formalized in the next month or so, is a boost to Pakistan’s external stability in FY25, JPMorgan's analysts wrote.

However, the report cautioned about several downside risks.

One, political risk in the form of opposition rallies remains in the background, despite better government stability since the February elections.

Two, Pakistan has a history of fiscal slippages due to overly optimistic revenue/GDP assumptions and ad-hoc spending increases.

And three, public debt sustainability remains a medium-term risk, given the elevated debt servicing burden and the crowding out of private sector credit.

Copyright Mettis Link News