State Bank of Pakistan likely to keep policy rate unchanged

Karachi: The State Bank of Pakistan (SBP) is scheduled to release the first Monetary Policy Statement (MPS) for FY12 on July 30, 2011.

According to Arif Habib Limited, Arif Habib Limited expects the SBP to maintain a status quo with keeping the discount rate at 14%. The central bank has kept the policy rate unchanged for the last three consecutive MPS. We believe that the stable inflationary outlook and steady external accounts will be the major factors in keeping the discount rate unchanged.

Inflationary pressure has descendent…
Inflationary pressures that were high at the beginning of FY11, and have remained at elevated levels during much of the 1HFY11, started to decedent from Jan’11 onwards. For instance average inflation in 1HFY11 stood at 14.59% YoY in comparison to 13.28% YoY in 2HFY11, on average. This allowed SBP to keep policy rate unchanged following the Jan’11 MPS. The CPI inflation for FY11 stands at 13.9% YoY (+0.1 real interest rates); lower than the SBP and market participants’ projection. Going forward with global commodity prices gradually easing in particularly food prices, alongwith high base effect (in 1HFY11) will restrict inflationary pressures. We expect 1HFY12 average headline inflation to be at 12-13% YoY.

While high government borrowing may post a key risk in medium-term
However a key risk to inflationary pressures remains higher government borrowing, which likely, breaks in with 3-4 month lag affect. To date total borrowing from SBP and schedule banks stands at PKR 64bn. Although the government is now meeting major chunk of its borrowing requirement through schedule banks rather than SBP, which however has the potential to raise yields in the secondary market and thus policy rate. We on the other hand believe that the SBP will keep the market liquid through regular OMO’s in order to avoid a major credit run.

Improvements in external accounts render some stability…
On a similar note the current account for FY11 has posted a surplus of USD 542mn (+0.3% of GDP) showing a considerable improvement over a deficit of US$ 3.9bn (-2.2% of GDP) last year. This was mainly on account of a 26% YoY growth in exports and a 29% YoY jump in workers’ remittances. Strong growth in external flows consequently marks underlying improvement, which helped in building the foreign exchange reserves above ~US$18bn. However going forward we might see some respite in overall exports as global commodity prices fall.

However lack of external funds may post a threat in FY12…
Improvements in the external account have led to the increase in NFA (incurring a ~70% YoY growth) which has led to reserve money growth at 17.06% YoY. Although this being favourable composition in reserve money but on the flip the growth in its NDA (+ ~11% YoY growth) component has resulted in inflationary pressure. Going forward, lack of external funds will certainly push towards government reliance more onto domestic sources, which can further push NDA causing the reserve money growth and hence inflation.

A stable monetary outlook is depicted by stable secondary market yields. With no major threat to the current account seen in the medium to long-term, the SBP has adequate room to continue a monetary laxity. We see monetary easing to start off by 2HFY12 given the projected headline inflation tapering off at 12-13% YoY and lower budgetary borrowing from the SBP.

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