JS Securities Limited - JS Research (July 13, 2022)

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JS Securities Limited – JS Research (July 13, 2022)

July 13, 2022

Karachi, July 13, 2022 (PPI-OT): 125bp PR hike: Moving parts keep guidance unclear

With the sixth round of Policy Rate hike in current cycle, SBP announced another 125 bp increase last week, taking Policy Rate to 15% and Export Finance Scheme (EFS) and Long-Term Financing Facilities (LTFF) up to 10% (500 bp below PR).

Reason cited for the hike is that SBP intends to further moderate economic activity and anchor core inflation. Despite 675 bp increase in PR in eight months (800bp including latest hike), pace of economic activity did not slow down to the required level.

SBP expects FY23 CPI to average ~18% – 20% (in-line with our estimates). Historical data reveals SBP has not matched PR to temporarily high and low inflation points, suggesting that contained commodity prices could limit the pressure on rate hikes.

Despite the massive 800bp adjustment in rates, the uncertainty however continues to be driven by pressure on the Rupee and need to accumulate reserves, leaving opinions divided on path of interest rates amongst market participants.

Policy Rate increased by 125 bp to 15%

With the sixth round of Policy Rate hike in current cycle, the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) announced another 125 bp increase last week, taking the Policy Rate up to 15%. This was broadly anticipated, with 100 bp already part of our base case projections, where shorter tenor PKRVs and KIBOR of 3M to 12M tenors have already been trading around 15%. The cumulative increase since the start of the ongoing monetary tightening in Sep-2021 has been 800 bp. The yield curve is still inverted with 3YR to 10YR closer to 13%.

To improve the translation of monetary tightening, the MPC also linked the Export Finance Scheme (EFS) and Long-Term Financing Facilities (LTFF) to the Policy Rate (previously fixed at lower rates), keeping it 500 bp lower than the Policy Rate at 10%. This reflects an increase of 250 bp in the EFS and 300 bp increase in the LTFF rates.

To anchor the increasing core inflation

While ongoing higher inflation readings is a result of both, higher global commodity prices and supply bottleneck issues and the domestic demand pull, SBP continues to address the latter by continuing monetary tightening. Core inflation has also been on an increasing trend. Moreover, most items in the inflation basket have witnessed more than 6% increase – a benchmark the central bank had set to control headline inflation at its previous target of 5% – 7%.

Despite the 675 bp increase in the Policy Rate in eight months (800bp including the latest hike), the pace of economic activity did not slow down as much as required. Hence, SBP intends to further moderate economic activity and continue anchoring core inflation with continuation in monetary tightening. The ongoing monetary tightening is expected to bear fruits with more effectiveness as FY23 has strong fiscal consolidation stored in.

Higher CPI and moderate growth expected in FY23

While global commodity prices have begun to soften, however, it is too early to say if the drop so far will support Pakistan’s route to controlling the inflated import bill, therefore these will be continued to be monitored. The central bank expects FY23 CPI to average between 18% – 20% (in-line with our estimates) over higher price levels. While current Policy Rate levels reflect a negative real interest rate of 300-500 bp, the central bank views CPI at a declining trend till FY23-end, and further at 5% – 7% by FY24-end.

The Governor apprised ongoing situation in the global markets as developing, hence would be able to provide guidance with more clarity in hand. However, the central bank did not rule out timely measures in the future. For FY23, GDP growth is expected in the range of 3% to 4%, lower than FY22 (P) growth of 6%, while CAD expectations remain unchanged at 3% of GDP (FY22E: 4.5%).

Despite SBP expectations of 18% – 20% CPI, historical data reveals SBP has not matched PR to temporarily high and low inflation points, suggesting that contained commodity prices could limit the pressure on rate hikes.

High D/Y plays still attractive

Incorporating all taxes and higher energy prices in FY23, PSX forward earnings yield are still at 25%, towering above prevailing 12M bond yield of 15%. While on IMF, the governor apprised the talks reaching to the final stage with expectations of a Staff Level agreement soon as most of the difficult decisions i.e. (1) hike in petrol prices and decision to implement un-winding of other energy subsidies, (2) resumption of levies and (3) approval of Federal Budget FY23 have been executed, lack of clarity on IMF deal seem to be playing a major role driving the lacklustre interest in equity markets.

We highlight higher D/Y plays such as UBL, MCB, BAFL, ABL and HMB among the banking space as higher interest rates further strengthen the sector’s earning yields. Our projected dividends offer a D/Y of 15% – 19% despite higher credit costs. From other sectors, we prefer FFC, EFERT, ENGRO, HUBC and MARI.