In March monetary policy meeting (due tomorrow), we expect the State Bank of Pakistan (SBP) to raise the policy rate by 50-75bps from 9.75% to 10.25-10.50%. The key variable which has changed since the last MPS in January is the global scenario. Russian-Ukraine war and its impact on global commodity prices (not just that of crude oil) have materially worsened the outlook for inflation and current account deficit in Pakistan; which puts the onus on monetary policy to stabilize the economy.
Key reasons for our expectation are:
We expect National CPI to average c.11.0% in the next 12 months (c.13% until June). If present levels of commodity prices persist for long (such as crude oil prices remain above US$120/bbl), we estimate a monthly CAD of US$2.0-2.5bn, despite some demand deterioration (Petroleum imports estimated around US$2.5bn per month at c.US$130/bbl).
The SBP has hitherto guided that it will look through transitory changes in inflation and is taking cues from core inflation for MPS. But, not increasing interest rates at this stage will risk sharp PKR depreciation (over 5%), which will in turn increase core inflation in due course, in our view. Delaying policy rate increase will warrant sharp increases in future (as happened in late 2021).
The Fiscal side is no longer as supportive of moderate monetary policy, thanks to subsidies on fuel and power. This creates two problems. First, subsidies risk a liquidity crisis across various sectors and can balloon into a larger fiscal deficit amid ever-increasing oil prices. Second, higher fuel prices would have automatically moderated demand; but not doing so undermines the efficacy of monetary policy, in our view.
The Relief Package may undermine the continuation of IMF Program (we see low probability) and realization of multilateral capital flows until September 2022; which are paramount for Pakistan to withstand the widening current account imbalance in the present global scenario, in our view.
Growth in FY22 (projected c.4.5% by the SBP) is largely coming from Agriculture and Services, thanks to higher commodity prices. Hence, greater monetary tightening should not undermine growth.
Pakistan equity market closed down c.3% today, as several risk factors have emerged together: (i) balance of payment crisis in light of rising commodity prices and worsening CAD; (ii) security concerns following the attack in Peshawar on Friday; (iii) risk of political instability, as the Opposition is threatening a no-confidence vote against the government; and (iv) geopolitical concerns as Pakistan’s neutral stance on Russia’s aggression is risking strained relations with the US and EU. Notably, the KSE-100 has corrected c.3% CY22td compared with c.5.0%/c.9.0% for MSCI EM/FM index (partly because of significant underperformance of Pakistan market in the past two years). We remain constructive on the Pakistan market but advocate cautious stance for the near term. Our Strategy 2022 already advocates tilt towards defensive sectors.
Courtesy – Intermarket Securities Limited