Karachi, January 17, 2023 (PPI-OT): 100bp hike likely in upcoming MPS, more may follow

We preview Monetary Policy to be announced on 23rd January, 2023, expecting State Bank of Pakistan to continue with monetary tightening. We expect 100bp hike, taking Policy Rate to 17%. Our expectation stems from recent developments indicating government and regulator (SBP) making all efforts to secure progress ongoing IMF program.

We also highlight, the latest Staff Report of the Fund reports SBP agreeing to achieving real positive interest rates and accomplish inflation target range of 5% – 7% over the medium term. Hence, further tightening this year may not be ruled out.

To note, longer tenor secondary market yields have moved up ~140bp post Nov-2022 MPS announcement, while shorter tenor yields have inched up ~20bp during the same time, which reflects changes in investors’ long-term interest rate outlook.

Expect 100bp hike as inflationary pressures continue

We preview the Monetary Policy to be announced on 23rd January, 2023, where we expect the State Bank of Pakistan to continue with monetary tightening and announce a further 100bp hike, taking Policy Rate to 17%. If so, the benchmark interest rate would go to a 25-year high, where last the interest rate (which was the Discount Rate before) were at these levels was in the late 90s.

Our expectation stems from the recent developments that indicate the government and regulator (SBP) are making all efforts to secure progress on the ongoing IMF program, which has not shown much progress on its 9th review pending since Nov- 2022. To recall, advancement in IMF’s program would unlock fresh FX inflows for Pakistan, where import cover has now dropped to just 4 weeks.

The recent developments include progress on resolution of pending gas circular debt, reduction in subsidized loan rates for exporters and industries for expansion etc. Hence, given the country’s escalating core inflation trend, we believe SBP would also take IMF’s recommendation to continue using monetary tools that would help to reduce inflation and address external imbalances.

Deep negative real interest rates

The sharp monetary tightening so far (900bp since Sep-2021) has 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. Inflation trend, however, maintains its upward trend, averaging at 25% in 1QFY23 and 2QFY23. Given ongoing headline inflation trend, the negative real interest rates still stand at ~900bp. We highlight, the latest Staff Report of the Fund also reports SBP agreeing to achieve real positive interest rates and design a policy to accomplish the inflation target range of 5% – 7% over the medium term. Hence, further tightening this year may not be ruled out.

Shift interest rate outlook

Analysing money market indicators, investors are not only expecting a hike in the upcoming MPS announcement, but also a lower than previously expected monetary easing.

To recall, around Oct-2022 view on Policy Rate in some quarters of the market were shifting from ‘higher for longer’ to ‘reversal’, which we believe is now returning to previous base case. The longer tenor secondary market yields of the money market have moved up by ~140bp post the last MPS announcement in Nov-2022, while shorter tenor yields have inched up by ~20bp during the same time. This has also contracted the negative spread between 3YR and 3M secondary yield to 8- month low. Nonetheless, as yield curve remains inverted, the market expects ongoing tightening to be short lived.