Karachi, November 28, 2022 (PPI-OT): SBP resumes monetary tightening citing rising core inflation

In a somewhat surprising move, State Bank of Pakistan (SBP) announced a 100bp increase in Policy Rate, taking it to 16%, the highest levels since 1999. After keeping rates unchanged in the previous two monetary policy announcements, resumption of tightening is led by rising core inflation that has now reached 17% (as compared to low double digits some months ago).

Despite the surprise move, a larger concern of market participants in SBP’s post MPC briefing session was country’s external account position its capability to service scheduled payments over the next 12 months.

SBP governor responded to those concerns by apprising that SBP expects foreign exchange reserves as at FY23-end to be higher than current levels given the strong pipeline of inflows versus external payment commitments.

Policy Rate increased to 24-year high at 16%

First time since 1999, Pakistan’s Policy Rate has touched 16% after the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) increased Policy Rate by 100bp to 16% on Friday. The increase follows 800bp increase in the Policy Rate since Sep-2021, out of which 525bp was witnessed during 7MCY22. Since July-2022 the MPC has opted to keep the PR unchanged for two Monetary Policy announcements before resuming tightening this month. To note, banks’ treasurers had highlighted an increase expectation in recent corporate result calls, while the move was a surprise to other quarters of the market.

As core inflation trend goes beyond expectations

The sharp monetary tightening so far had begun to reflect in economic slowdown. In the last couple of months, large scale manufacturing has been reporting negative growth, while imports have also considerably declined over reduction in demand and some administrative measures taken to control the same. These results had made SBP to opt for pause in the previous two announcements as well, realizing the country is expected to stay in the negative real interest rates zone of almost 500 – 700bp for the next 2 to 3 quarters or so.

What changed since then is the rising core inflation, though a trend visible since the last 8 months. Core inflation has now crossed the Policy Rate level of 15%, reaching almost 17%, which needs to be tamed. SBP’s broader macro indicator estimates for FY23 remains unchanged with CPI at 21-23%, GDP at 2% and CAD at 3% of GDP. Moreover, SBP also still expects FY24 CPI to fall in the range of 5 – 7%.

External position – a greater concern right now

In SBP’s post MPC briefing session, much concern was gathered from market participants upon declining remittances and delay in prospective support from friendly countries and other funds. Both that are damaging to SBP’s projected foreign exchange position where import cover stands at 1.7x.

SBP governor responded to those concerns by apprising that SBP expects foreign exchange reserves as at FY23-end to be higher than current levels given the strong pipeline of inflows versus external payment commitments. Moreover, the governor also assured payment of the upcoming US$1bn maturing Eurobond to be made smoothly. In the near term, US$500mn from AIIB is expected to be received by next week. In addition, US$7bn worth loan payments have also been rolled over.

Corporate profitability and equity markets

The interest rate increase announcement would likely interrupt the uptrend momentum witnessed this month so far. We expect corporate profitability to slightly revise downwards for cyclical sectors over higher levered books, despite some portion of debt under subsidized rates. Moreover, higher interest rates would also further dampen auto sector volumes amid further discouraging auto financing rates. So far the share of sales from auto financing has already declined from ~35-40% before the start of monetary tightening cycle in Sept-2021 to now 15%. On the other hand, the sector’s other income would benefit as it maintains a higher cash balance as compared to debt on books.

E and Ps, Engro Corp (ENGRO) and Lucky Cement (LUCK) are other sectors and companies that are expected to benefit from higher other income as well. Among other key beneficiaries would be banks, with immediate cost increase and a lagged impact of asset re-pricing, resulting in NIMs expansion in the coming quarters. We highlight some tenor yields have already moved up by 15 – 20bps in two weeks, while KIBOR is up 15bp in the last one month. We hence do not rule out an earlier asset re-pricing, similar to what happened at the start of the year. As we write this note, secondary market yields have already jumped by 60-70bp from Friday’s close in the shorter tenors, while some longer tenor instrument yields have increased by 40bp.

We believe much discount to the local bourse multiples is already priced in. We expect clarity on external support to unlock PSX valuations which are currently trading at P/E of ~3x. Till then, we recommend high D/Y stocks such as UBL, BAFL, POL, HMB and MCB with sustainable D/Y above the Policy Rate.