Morning Call about – Arif Habib Limited

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Karachi, June 20, 2013 (PPI-OT): Monetary Policy Statement may opt for ‘status quo’, why?

Monetary Policy Statement may opt for ‘status quo’, why? At a time when Arif Habib Limited’s economy faces pressing challenges such as weakening external account with mounting risks of depreciation of the PKR amid reduced import cover (less than 3 months excluding IMF portion), bloating fiscal deficit with risks associated with delayed energy reforms, it may once again keep the central bank from going generous with the monetary policy that is to be held tomorrow.

According to Arif Habib Limited, external weaknesses and borrowing may hold the SBP this time too at the same time, recently, the SBP has also indicated in its last quarterly report that despite easing inflationary pressures, rising weakness in the external account poses challenges to monetary easing. In this regard, supporting central bank’s argument of no easing, the report highlighted the decline in forex reserves by around USD 3.7bn to USD 12.25bn (which further down to USD 11.45bn currently) while PKR also lost value by 3.9% (further down to 4.4% FY’13TD). In addition, gov’t borrowing from the banking sector has been once again mounting given significantly lower-than-targeted tax revenues.

Government’s budgetary borrowing from the financial sector stood at PKR 1.23tr, up 4% YoY (PKR 817bn from banking sector, up 20% YoY, PKR 413bn from the SBP, down 18% YoY).

Inflation alone cannot fight for a rate cut

So, given the external account weakness and the borrowing position of the gov’t, decline in the headline inflation alone will no longer be enough to spur the State Bank of Pakistan to cut interest rates. This is because inflation seems to be picking up its intensity and is expected to clock in around 6.6% YoY during the month of Jun’13. On a monthly basis, this marks around 1.5% uptick in the overall inflation. With June’s inflation figures, the base effect seems to be completely fading away. With this, the average inflation FY13 would stand around 7.43%, comfortably contained vis-à-vis FY13 target of 9.5%.

Though core inflation remains a key point in favor of a cut

The SBP may opt for a status quo given fiscal and external weaknesses, however, continuously declining core inflation (non-food, non-energy), from 10% in Jan’13 to 8.1% in May’13, may stir some of the decision-makers at the SBP to be in the favor of a rate cut, albeit a token of 50bps.

Further, not denying the fact that the need of the hour is to support investment that can be achieved by central bank’s ensuring the cost of financing stays affordable for the end-user, alongside timely resolution of the energy crises. This MPS seems to be the last point in 2013 when the central bank may opt for easing as, from here onwards, inflationary pressures are expected to increase given 1) 1% increase in GST and other tax measures, 2) Ramadan effect (from mid-July) when food prices often soar, 3) end of low-base effect for inflation. Thus, this is a crucial point for SBP to decide upon a rate cut now or keep status quo for the rest of 2013 (assuming no significant foreign flows materialize in 2H2013).