Policy Rate unchanged though warrants a cautionary outlook! The State Bank of Pakistan (SBP) in its CY14-start review of monetary policy on Friday kept the policy rate unchanged at 10% and the repo rate at 7.5%, respectively. According to Arif Habib Limited , this was in line with Arif Habib Limited’s estimates and the market consensus. The central bank report highlighted: ”Although there are some risks to the balance of payments position due to uncertainty surrounding expected foreign inflows, expected increase in inflation is slightly lower than anticipated earlier. In view of the above, the Board of Directors of SBP has decided to keep the policy rate unchanged at 10.0 percent.“ Inflation has moderated... After witnessing a jump in 1HFY14 - 8.9% versus 8.3% last year same period, primarily on account of higher supply-side push from perishable food items - the outlook seems rather tamed, with high probability of meeting SBP target of 10.0% - 11%. The MPS further states: ”Nevertheless, SBP expects average CPI inflation for FY14 to fall between 10 to 11 percent, which would be higher than the target of 8 percent announced by the government. Other than attending to external sector risks, the reason for recent increases in the policy rate is also to manage expectations in the wake of expected inflation remaining higher than the target and restrict decline in real interest rates.“ ...but, fragile external accounts In view, the widening current account deficit, albeit manageable - USD 1.9bn in 5MFY14 versus USD 0.7bn same period last year - is indicative of demandsupply imbalances - mainly arising from lower exports and weaker realisation of capital inflows. ”The overall current account deficit for FY14 is projected to increase. However it is not deemed very high by historical standards and does not seem to pose risk to the external sector.“ - SBP Monetary Policy Statement Jan-13 And with that said, it needs more systematic resolution through raising tax revenues and external inflows. ”The external current account deficit and its financing rests with inflows like CSF, 3G license fee, privatization of PTCL related inflows, and issuance of euro bond. Absence of these flows could potentially result in a balance of payments deficit as against an anticipated surplus for FY14. Together with net repayments to the IMF for FY14, this suggests that there are some risks to the balance of payments position.“ - SBP Monetary Policy Statement Jan-13 ...and, meeting fiscal contingencies Moreover, during the 1HFY14, IMF-based target pertaining to fiscal borrowings from SBP was met but it was primarily done through outright sale of government securities, which shifted the burden on to scheduled banks, causing an overall system liquidity squeeze. This combined with SBP front-loaded policy rate increase in Sept-13 and Nov-13 - on the premise of expected fiscal consolidation - may hamper recent revival in private credit off take, implying that the growth will stay low for longer before Arif Habib Limited can see a meaningful decline in inflation below government targeted rate of 8%. ”A key risk to the fiscal position is a possible shortfall in tax revenues, recurrence of energy sector circular debt, and delays in budgeted foreign inflows. Such deviations could lead to increase in borrowings from the banking system, further accumulation of domestic debt and higher-inflation.“ - SBP Monetary Policy Statement Jan-13 Warrants a rather cautionary outlook Arif Habib Limited believes, inflation pressures remain intact because of high fiscal deficit financing, price distortions in input prices (fertilizer, oil, electricity, supply-side issues), and the adverse impact of food inflation and on expectations. Moreover, with inflation touching double-digits in coming months (excluding Jan-13) and SBP view of keeping real rate positives, it’s just a matter of time for market to anticipate a rate inch-up. Outlook In base-case scenario, Arif Habib Limited foresees a 50bps hike in SBP policy rate in 1HY14 or early start of FY15. Primarily on the back of weakening balance of payment position, higher inflation outlook and slow fiscal consolidation.
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