Macro Analysis /

Pakistan – MPS review: Central bank acts as the adult

  • The SBP has raised the Policy Rate by 250bps to 12.25% on a higher inflation outlook and risks to external stability

  • Central bank has acted appropriately and decisively to shore up confidence, but politics retains paramount importance

  • Higher secondary market yields since March have anticipated rate hike, which may limit the negative impact on equities

Raza Jafri
Raza Jafri

Executive Director, Research

Intermarket Securities
8 April 2022

The SBP has increased the Policy Rate by 250bps to 12.25% in an emergency meeting held today, the first interest rate increase this calendar year. Given a deteriorating outlook for inflation and rapidly slipping PKR, in the backdrop of heightened domestic political uncertainty, the SBP had to act swiftly and decisively to shore up confidence. Today’s move should help achieve this objective, but politics still retains paramount importance for macroeconomic stability, in our view. The central bank has also increased export refinancing rates by 3.0ppt to 5.5%, and increased cash margins on a wider set of imported items (mostly finished goods; raw materials not included).

The reasons for the interest rate increase are:

  • Outlook for higher inflation, on the rise in core inflation (has entered double-digits on rural side) and sticky international commodity prices, especially oil 

  • Risks to external stability, captured by the recent 5% slip in the PKR and lower Fx reserves, even as the FY22 external funding needs are fully met

  • Expectations for a quicker increase in US interest rates, and therefore globally

The SBP expects CPI to average 11% in FY22 before moderating in FY23. While we see upside risks to the inflation outturns, particularly if the PM’s Relief Package is reversed, today’s interest rate increase reinstates mildly positive interest rates from a forward-looking perspective. It also narrows the gap with secondary market yields where the cutoff on the 12m paper came in at 13.30% in yesterday’s auction.

Impact on equities

The 250bps rate hike comes in higher than consensus expectations, with the central bank feeling the need to act decisively. That said, with secondary market yields already having risen by c. 230bps since the start of March, the higher interest rate environment may already be greatly priced in by the equity market, especially as the central bank seemed to indicate that it is done with monetary tightening for now. Cuts to analyst estimates will likely come through (see table in the report), but valuations remain attractive – the discount to 10yr average Market Capitalization to GDP is already a wide c.30%.