Macro Analysis /

Pakistan: Large interest rate hike ahead of IMF program

    Saad Ali
    Saad Ali

    Head of Research

    Intermarket Securities
    21 May 2019

    The SBP has increased the policy rate by 150bps to 12.25% (discount rate is now 12.75%). The central bank has based the decision on: (i) inflation looking to be considerably higher in FY20 (vs. 7.3% estimated for FY19), (ii) recent exchange rate depreciation (PKR has devalued 5.5% this month) and (iii) an elevated fiscal deficit that has diluted the impact of previous interest rate increases. This was the first monetary policy announced after the staff-level agreement with the IMF. Together with the fresh PKR depreciation, the rate hike is in keeping with the “prior conditions” Pakistan has to fulfil ahead of the IMF Board’s approval.

    The large increase in interest rates takes into account the inflationary outlook, as we estimate CPI to average above 10% in FY20f. This is due to the (i) aftereffects of recent PKR devaluation, (ii) prospects of significant increases in power and gas tariffs (both lifted monthly CPI readings by 1ppt in their previous changes), and (iii) tax increases in the upcoming Budget (talk of a 1% increase in GST). If CPI consistently averages 11% or more, led by the aforementioned factors, together with unforeseen volatility in food inflation and global oil prices (US-Iran spat), then interest rates could increase further. Even in this scenario, however, it is difficult to see too much monetary tightening from here.

    Banks: Asset quality more important than margin expansion

    The more margin-sensitive banks such as MEBL and BAFL have significantly outperformed other banks as well as the KSE-100 since monetary tightening began. They will benefit again in the immediate term; but, given the slowdown in the economy, they are also likely to face relatively greater asset quality pressures. We think the market has adequately priced in the margin expansion theme, with the next leg of banking sector performance to be determined by local asset quality dynamics. MCB, ABL and UBL stand out in this respect based on: (i) low consumer & SME exposure, (ii) large lending to the government and the power sector, and (iii) relatively cautious loan growth in the last few years. 

    Relative attractiveness of the market diminishing

    The KSE-100 has shed more than 4% since the staff-level agreement with the IMF, and has continued the downtrend after yesterday’s interest rate increase. Our coverage universe now trades at an estimated 2020f P/E of 6x, which has historically represented trough valuations for Pakistan. This may prevent further sharp corrections in the market. However, given that monetary easing looks unlikely in the next 9-12 months, the Index may have to wait until next year to stage a sustainable rally. 

    Source: Intermarket Securities