Karachi, August 05, 2022 (PPI-OT): Divergent views on Policy Rate starting to emerge

Pak Rupee is undergoing unprecedented volatility as macro headwinds and political noise rendered Jul-22 to be the worst month for PKR (-14%) since May 1972; followed by a chunky DoD appreciation of 4.2% (PKR9.65) seen on 3rd August.

Recovery in PKR, softening int’l oil prices and slowdown in select demand indicators have started creating divergence in policy rate expectations for MPS on 22nd Aug. Participants are also taking a cue from moves in PKRV to firm up their expectations.

We conducted a brief survey of money managers to gauge where the consensus was leaning between above factors and need to address CPI pressure which is expected to hover over 20% YoY for next few months. Our survey reveals 63% participants expect a hike between 50-200bp. More interestingly however 37% respondents now feel that SBP will opt for status quo.

We maintain our view of 150 bp hike. We believe need to address negative real rates will outweigh recent nascent positives.

Unprecedented volatility in Pak Rupee

Pak Rupee witnessed an unprecedented nosedive devaluing 14% during July-2022 (highest drop since May-1972) and 32% in the past one year. In addition to bleak macroeconomic indicators, it is understood that weaker sentiments due to political noise also had a part to play in this devaluation.

This was followed by a sharp rebound where PKR has recovered 5.4% in last two days, where it appreciated 4.2% (+PKR9.65 DoD) in one day alone, marking the largest DoD appreciation since Aug-1999. The revival in confidence so far has also been reflected in the equity markets (up 3.1%) and international bond markets (Dec-2022 bond YTM down by 21 ppt to 30%) in the last two days.

Beginning to create divergent views on policy rate

The nascent recovery in PKR and other macro and political developments have started creating divergence in policy rate expectations for MPS on 22nd August. Participants are also taking a cue from moves in PKRV to firm up their expectations. This is in contrast to the widespread view of further hikes being inevitable till a few weeks ago.

To gauge the quantum of changed expectations, we conducted a brief survey of money managers to assess where the consensus was leaning between above mentioned factors and need to address CPI pressure, as CPI is expected to hover over 20% YoY for next few months. Our survey reveals 63% participants expect a hike between 50-200bp. More interestingly however 37% respondents now feel that SBP will opt for status quo.

What are the two camps basing their views on?

Respondents expecting Status quo: In addition to PKR appreciation, institutions with view of status quo in Policy Rate base it on (1) impact of to-date monetary tightening which has begun to slowdown economic activity, proxy being lower cement, autos and OMC sales, (2) declining trend in oil prices and (3) 47% MoM decline in Jul-22 trade deficit. The respondents believe that these reasons will likely lead the Monetary Policy Committee (MPC) to adopt a wait and watch approach.

Respondents expecting further Monetary tightening: On the other hand, investors expecting continuation in monetary tightening are of the view that a consistent trend in PKR appreciation, lower current account deficit and lower economic activity might be needed by the MPC before it can be concluded that the increase in Policy Rate so far is sufficient for the heated economy to cool.

Moreover, common concerns that emerged were (1) the sustainability of a US$2.6bn trade deficit as it includes a certain impact of pre-buying of oil in the earlier months and (2) persisting higher CPI readings expectations for the next 10 – 12 months.

Another factor that was repeatedly mentioned was that July economic data contains a number of one-offs (Eid holidays, heavy monsoon rains and pre-buying ahead of budget in June) and hence data points of the next few months would have to be dissected to accurately gauge the impact of the increase in interest rates from 7% to 15% (cumulative 800bp).

We reiterate our view of 150bp hike

We maintain our view of 150 bp hike taking the Policy Rate to 16.5%. We believe need to address negative real rates will outweigh recent nascent positives. Given our expectations of CPI reading continuing to clock in above 20% (assuming oil prices of US$97/bbl) for most of the current fiscal year, we believe that the same will continue to weigh on policy rate decisions, till international commodity prices and domestic food inflation show a sustained declining trend.