JS Securities Limited – JS Research (29-06-2020)

Karachi, June 29, 2020 (PPI-OT): Easing over unless pandemic demands it

The latest 100bps slashing of the policy rate, although an outcome of an emergency meeting of the MPC, was not completely unexpected. There were whispers of an impending cut and the bond markets had more or less priced in the quantum.

From now onwards, the inflation outlook and deficit financing needs seem to suggest that monetary easing is over. However, this is not set in stone and a rate cut may still be possible if the pandemic worsens.

The latest rate cut seems less surprising if we take a global view and account for the deteriorating growth forecasts and consider the steps taken by Central banks across the world.

Bond yields should remain sticky across all tenors in the short term as investors try to regain some sense of direction.

The latest 100 bps reduction in the policy rate marks the fifth consecutive cut by the SBP since monetary easing began in Mar-2020. What makes this round unique is that despite being the outcome of an emergency meeting of the MPC (the third one this year), there were already whispers in the market of an impending cut, which was evident through what the bond market had already priced in. Even the equity market’s reaction to the news on Friday was rather composed, as it recovered from the slight correction seen of late.

We had highlighted in our note on the last MPC decision that the SBP Governor’s tone was more than supportive of the markets and seemed willing to take out-of-the-box measures if required. Even then, some corners of the market were expecting a status quo in the May-2020 decision. Yet, here we stand, 200 bps lower. What can be expected henceforth is contingent upon the trajectory of Coronavirus infections in the country. Further rate cuts should not be ruled out if the situation worsens.

Domestically, we find that the room carries a hint of confusion. For instance, the rate cut by the SBP was almost immediately followed by a massive increase in POL prices by the government, which gives an impression of a lack of synchronization between the two bodies. This is not an anomaly but just a reconfirmation by the SBP that the inflation outlook is not as relevant as it would be under normal circumstances (ex-pandemic).

Granted inflation forecasting can be a tall order in Pakistan given shocks in prices of basket heavyweights. Still, the SBP had (till Mar-2020) stood its ground with a targeted medium-term inflation of 5-7%. But, the MPS in Apr-2020 shared an FY21 target of 7-9% while the latest one suggests that inflation may fall below this. However, it should be noted that this was before the sudden hike in POL prices. We feel this uncertainty should keep bond yields sticky across all tenors in the short term as investors try to regain some sense of direction.

Moreover, the massive 625bps cumulative fall in the policy rate can be seen in the recent PIB auctions which revealed weakened interest in the longer tenor bonds. Resultantly, the yield curve inversion has now become a thing of the past and a normal yield curve will reign once more.

The cumulative 625 bps rate cut should result in savings of nearly ~Rs700bn in debt servicing on domestic public debt in FY21. Interestingly, the budget documents show an increase in public debt servicing costs from Rs2.37tn in FY20 to Rs2.6tn in FY21 despite the impressive rate cuts. This can be simply explained by the fact that monetary easing started towards the end of FY20 and it would understandably take some time until all the loans to be re-priced. Secondly, further financing that is planned to take place over the next year also has a role, albeit a smaller one.

In addition, the MPS highlights that Rs3.3tn of loans from commercial banks (45% of the total loan book) are expected to be re-priced in July-2020. The timing of the latest rate cut could therefore go a long way in helping the monetary policy transmission.

The IMF – which is still more optimistic than the OECD – recently downgraded 2020 global growth projections to -4.9%, making this the worst economic crisis since the Great Depression. This has already cost governments around the world an unprecedented loss in revenues and public debt levels are expected to make history. Central banks everywhere have been at the forefront in tackling the pandemic and have already deployed a number of programs using reactionary and pre-emptive strategies.

The US Fed has taken the lead here purchasing trillions in treasuries and corporate bonds, resulting in its balance sheet assets jumping up more than 70% since the pandemic. As if that was not enough, the Bank of Japan’s yield curve control through a ceiling on yield of long-term bonds is being considered in other developed markets as well. In this light, the steps taken by the SBP do not seem surprising at all. However, considering what has already been done, further bold move would only be warranted if the pandemic worsens.

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