November 9, 2018 (MLN): The case for further hikes in policy rate continues to strengthen with every passing day. The State Bank of Pakistan is caught in a quandary as it juggles flaming inflation, widening fiscal and current account deficits and rising pressures on rupee. Although, the tightening policy is not a novel strategy as it has been used before time and again, the political costs are likely to affect the movement of rates going forward. The worrying factor, however, is the lack of consensus among observers as to how much and how many hikes are to be anticipated in the ongoing fiscal year.

In the previous monetary policy, the SBP raised policy rate by 100 basis points taking the cumulative rate hikes since January to mammoth 275bps. The underlying triggers for the rate have been rising inflation, widening deficits and pressures on the rupee. On the other hand, battered emerging markets and increasing crude prices have aggravated the situation further. Worryingly, analysts expect the EM economies to remain under duress as developed markets become more attractive and oil prices to maintain at their current levels if not rise any further.

The SBP announced its last monetary policy on 29th of September. Since then, there have been some major changes on almost all fronts.

Currency movement

On the eve of SBP’s last monetary policy announcement – 29 Sept, PKR closed at 124.26 against the greenback. However, in the second week of October Rupee closed the session at 134 down 7.83 per cent in just ten days. Following the abrupt jump, the currency trailed within the 132-134 range for the entire month.

The jump was preceded by a 10-20pc rise in gas tariffs affecting all consumers – commercial and residential – across the country, barring some select export-oriented sectors.

These rupee depreciation, despite being unpopular, were a long-time coming and was widely anticipated, however, it created a huge problem for the government and the central bank.

Four-year high inflation

Following the changes in the utility prices, analysts anticipated inflation to jump by wider margin and clock in at an estimate 6 per cent. However, much to everyone’s surprise, inflation clocked in at 7pc primarily led by the Y-o-Y increase of 105pc in the price of gas, coinciding with increase in house rent – up 6.72pc Y-o-Y, rise in prices of Motor Fuel – up 26.41pc Y-o-Y and education – up 11.54pc Y-o-Y significantly impacted the inflation index. 

However, most analysts questioned the methodology employed by the Pakistan Bureau of Statistics to factor in the changes by the gas price hike; the number itself has raised alarm bells in the general public. Market sentiment continues to favor SBP’s allowance of up to 7.5pc average inflation for the ongoing fiscal year.

MTB bid pattern

The market anticipation – read commercial banks – for the monetary policy changes can be seen in the bid behavior for monthly treasury bills.

In its last auction held on Wednesday, the SBP sold T-bills worth Rs.11.56 billion for three months. The pattern revealed that no bids were received for six and 12 months tenure.

However, the auction target was Rs.350 billion against a maturing amount of Rs.52.587 billion.

The bank accepted Rs2.148 billion at 8.80 percent in the competitive auction of the total received bids worth Rs.3.648 billion. On the other hand, non-competitive bids fetched Rs9.412 billion taking the total size of the auction to Rs.11.56 billion.

The pattern indicates the lack of buyers in the market for longer tenures – an early indication of market anticipations of a rate hike.

 The IMF Factor

The government is currently holding talks with the International Monetary Fund representatives to negotiate the terms of the bailout. Pakistan’s balance of payment crisis has been worsening ever since the oil prices began rising and exports stagnated. The incumbent government has been caught up in the worries over worsening economy as it goes from Saudi Arabia to China to seek immediate relief.

Saudi Arabia has agreed to lend $6 billion after PM Imran Khan visited the country with a delegation, China has also initiated preliminary talks to help the country out of the crisis and individuals privy to such information have also hinted at an approach to the United Arab Emirates for another $6 billion loan.

However, even if the government is successful in securing funds from ‘friendly nations’, it will have to agree to an IMF package to instill confidence among investors. The IMF agreement will help revive the lost confidence of investors and ensure other foreign lenders of country’s economic stability.

The lending, however, is likely to come at a cost as the government is likely to be pursued by the IMF to raise policy rates, devalue currency further during the ongoing fiscal year.

In general, market expectations for the coming announcements are varied with some estimating the SBP to raise rates by 50bps to others arguing their case for 100bps hike.

It is our opinion however, that since the next policy rate announcement will be the last one for the year, the State Bank of Pakistan will raise the rates by around 75bps so as to keep the overall figure in a single digit form.

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