In line with market consensus and its own guidance in the December MPS, the State Bank of Pakistan (SBP) maintained the policy rate at 9.75%. The SBP now sees both inflationary pressures and external imbalances moderating to manageable levels in the near future, and that adequate fiscal tightening ahead reduces the burden on monetary policy to contain demand. It has thus shed the end-goal of achieving moderately positive real rates (which had hitherto led to market expectations of PR peaking near 11%) and guided for more modest changes in the policy rate hereon.
Key takeaways:
Many indicators are pointing towards a slowdown in economic activity, which include: LSM growth of only 3% yoy in 5MFY22, slowdown in high frequency data (such as sales of cement, petroleum, autos and power generation), mom change in CPI falling to 0% in December vs 3% in the prior two months, and deceleration in imports and the current account deficit (which were both nearly flat mom in December). The SBP continues to expect GDP growth of 4-5% for FY22, but now more toward the center of that range (partly due to an upward revision of GDP growth for FY21).
Future outlook for inflation has improved, not just because of a recent deceleration in December (particularly in Food inflation), but also because of greater fiscal tightening ahead with the passing of Mini Budget in January. These factors cement SBP’s projection of medium-term inflation to average 5-7% (for FY23 and beyond).
The current account deficit, though still large until December (US$9.0bn during 1HFY22), is seen to have peaked as there has been noticeable decline in imports other than petroleum and vaccines. The SBP asserts that non-oil CAD in 1HFY22 was only US$0.7bn and that it is expected to turn into a small surplus by the end of FY22. It also reassured that present external buffers and capital commitments are enough to withstand a CAD as high as 5% of GDP (c.US$15bn).
Lastly, the MPC was emboldened by the outlook of greater fiscal tightening in future (triggered by the passage of Supplementary Finance Bill or Mini Budget) which has reduced the burden on monetary policy to moderate demand pressures.
The SBP has again strived to allay uncertainties in the markets about future interest rates, after having lived up to its guidance from the previous meeting. The MPS, in concert with the imminent resumption of IMF Program, also serves to rebuild confidence in economic stability and return to sustainable pro-growth policies in the near future. We think the equity market will react positively. In particular cyclical sectors, such as cement, steel and automobiles, should stage a rebound. We reiterate that the overall Pakistan equity market is trading close to trough valuations (forward P/E of barely c.5.0x), which has priced in a policy rate of at least 11%, in our view.