In line with market expectations, the State Bank of Pakistan (SBP) has kept the policy rate unchanged at 13.25% in the January 2020 monetary policy. This is the third consecutive status quo decision announced by the SBP after raising 100bps in the July 2019 MPS.
The SBP acknowledges that the recent inflationary pressures arose from food price shocks, but it continues to maintain its projected headline inflation at 11-12% for FY20f. The stabilization of the external account and exchange rate, build-up of its Forex reserves, and ongoing fiscal consolidation all support a softer inflationary outlook, according to the central bank. C/A deficit contracted 75% yoy to US$2.2bn and SBP's Forex reserves stood at US$11.7bn by mid-January (about 3mth import cover).
The SBP views high inflation readings in Nov-Dec'19 (above 12.5%) as transitory in nature drawn by temporary supply disruptions and upward adjustments in administered prices. That said, demand for faster wage growth, as a result of persistent food inflation, could lead to an elongated upward spiral of inflation. However, the SBP does not see any nascent signs of such second-round effects.
The SBP also highlighted that real interest rates in Pakistan are both below its long-term mean and also below the average level across the Emerging market countries.
Supply-side shocks have impacted cotton production; which, combined with contraction in LSM, has materially altered outlook for GDP growth. SBP is therefore likely to downgrade its real GDP growth projection for FY20 from 3.5% previously.
We think that the SBP is cognizant of the stress caused by the prevalent tight measures on economic activity (exacerbated by supply shocks). It is therefore willing to provide an impetus to the economy with any available tools, while monetary policy will continue to be governed by inflationary outlook only.
Alongside the statement, the SBP also announced its decisions to enhance the limits and scope of concessionary borrowing facilities for exporting sectors, which is considered to be the cornerstone of long-term macroeconomic stability – a view that matches that of the present government. The limits of the outstanding LTFF and EFF loans have been increased by PKR100bn each; while the maximum project size that is covered by these facilities has been doubled.
The SBP downplayed the role played by foreign portfolio money into domestic T-Bills (or hot money) in shoring up Forex reserves, which is attributed more to the reduction in the C/A deficit. These flows nonetheless reflect the confidence that foreign investors presently have in the creditworthiness of Pakistan.
We think that the SBP's cautious yet consistent stance – to cut interest rates only when inflation starts coming down – is commendable and raises confidence in the strength of the ongoing reform program. We believe monetary easing is likely delayed until at least May 2020, given the present inflationary trend. Even so, the SBP and the government's resolve to stimulate the economy when it is most appropriate, support our view that more pro-growth policies will be instated in near future – underlying market rerating and corporate profitability growth.