SBP bringing knife to a gun fight: Brokerage houses

KARACHI: No company/businessman would undertake new investment in the current uncertainty especially when they are already facing a liquidity squeeze, no matter how subsidized the funding facility is, said AKD research report on Wednesday.

New investments become largely insensitive to the funding cost at times of crisis, the report added.

The report claimed that the modest rate cut decision reflects the State Bank of Pakistan (SBP’s) obsessive focus on inflation, as the Monetary Policy Committee (MPC) of the central bank continues to weigh inflation more than domestic economic activity.

“The absence of any concrete measures to deal with the immediate economic fallout following COVID-19 makes us more worry about the readiness of the policymakers to deal with the imminent crisis,” the Report claimed. “The SBP’s only response in the form of Temporary Economic Refinance Facility (TERF) is same as bringing a knife to a gunfight and reflects policy incoherence,” it further added.

The SBP has reduced the policy rate by a modest 75 basis points.

The report said that the decision was accompanied by announcement of (i) Temporary Economic Refinance Facility (TERF) of Rs 100 billion for all manufacturing industries except power – which provides access to subsidized financing (at a max end-user rate of 7%) for setting up new industrial units (subject to max limit of Rs 5 billion per project) and ii) Refinance Facility for Combating COVID-19 (RFCC) of Rs 5 billion for hospitals and medical centers. While the central bank has maintained its average inflation forecast for fiscal year 2020 in the range of 11-12%, it now expects a relatively sharp decline in headline inflation towards its medium-term target range of 5-7%.

The SBP has revised down its GDP growth forecast for fiscal year 2020 to 3.0% (vs. 3.5% previously), incorporating weaker than previously expected agriculture growth and uncertainty following Corona outbreak.

From the monetary policy vantage, given its recent policy decision, the analyst expect the central bank to continue following the inflation targeting framework and the upcoming rate cuts would most likely be tracking inflation readings.

The report highlights the inflation outlook remains uncertain in the near term, with downside risks presently outweighing upside risks. The base case sees headline inflation averaging 10.3%YoY in the next four months (incl. March 2020), with the monthly reading declining to 9.6%YoY by June 2020. Given our base case inflation outlook, the aggressive monetary easing does not seem to be on the cards yet. The central bank’s response to economic stress as a result of Coronavirus would most likely be in the form of subsidized working capital facilities and regulatory relaxations for banks, the report said.

Banks: In another development, the SBP has decided to make the interest rate corridor symmetrical around the policy rate while maintaining it at 200bps. This in turn has widened the gap between Ceiling rate (known as discount rate) and the Policy rate by 50bps to 100bps and vice-versa reduced the difference between Policy rate and the Floor rate. Since the ‘savings rate’ is linked to the Floor, the move limits adjustment of 75bps cut in interest rate on savings accounts to 25bps – a clear negative for Banks which will witness asset returns re-priced lower than its saving deposits. The analyst said that we flag risks to BOP and HMB due to their higher exposure to Savings and Fixed deposits (77.1% for BOP and 70.0% for HMB). The development is neutral for Islamic Banks (MEBL).

Investment Perspective: From market’s perspective, the Pakistan Stock Exchange (PSX) is likely to tread the same path as international markets given the seriousness of the COVID-19 endemic has just started setting in domestically. Recent developments including the spike in cases within Pakistan as well as partial shutdown of major cities currently underway bode unwell for the broader economy and resultantly, the PSX. At the same time, quantitative steps undertaken by the policy makers are clearly inadequate to stem the panic currently developing. To gauge, the Trump administration yesterday announced a stimulus in excess of US$1 trillion, resulting in a knee jerk euphoria by investors, however, at the time of writing this report, the Dow30 Futures are limit down.

Pakistan’s fiscal response is virtually non-existent in comparison. Investors are recommended to stay on the sides.

According to the Topline brokerage house the latest move by SBP follows aggressive emergency rate cuts by its global counterparts to combat coronavirus pandemic that has jolted financial markets and the world economy, it falls short of street expectations.

In a survey conducted by Topline Research before the spread of the coronavirus, 80 per cent of the fund managers were expecting 50-100bps cut in Policy Rate. That said, a similar poll conducted yesterday revealed that 80% of the fund managers have revised their expectations to a 100-200bps cut in Policy Rate.

While acknowledging that medium term inflation target of 5-7% is likely to be achieved earlier-than-expected due to steep fall in international oil prices and deceleration in domestic food prices, the SBP opted to conservatively cut the Policy Rate by just 0.75% – even though the Pak economy is also likely to face significant impact of coronavirus outbreak, the report said.

The Topline report said that the SBP in the MPS has also decided ‘to make the interest rate corridor symmetric around the policy rate, in line with the international best practices’.

The analyst believes this will result in Minimum Deposit Rate (MDR) to decline by 0.25% to 11.0%, whereas on the other hand the lending rate will come down by 0.75%. MDR is applicable on Savings deposits, which are 40% of the total deposits.

The move will be good for the depositors, whereas commercial banks (excluding Islamic Banks and Islamic Operations) are likely to take a hit.

The Islamic Banks and Islamic Operations will not be affected directly from this change as MDR is not applicable on them, however they may try to keep their rates competitive vis-à-vis the commercial banks.

The analysts estimate a likely earnings decline of 5-14 per cent due to this change in interest rate corridor on Pakistan’s conventional banks, assuming everything else remains constant.

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