FLASHNEWS:

JS Securities Limited – JS Research (September 21, 2021)

Karachi, September 21, 2021 (PPI-OT): SBP raises policy by 25bps to signal sustainability of growth

SBP has raised policy rate by 25bps in a move which is measured and gradual. This comes after pace of economic recovery exceeds expectations and authorities administer controlled actions to handle COVID-19’s virulence. The moderate tapering of the good significance in the economy, present over last 18 months, anchors sustainability of growth momentum and ensures investor confidence.

Rate hike is measured and gradual: SBP has increased policy rate by 25bps to 7.25% as strength of robust recovery in domestic demand overshoots the assessment done two months ago in Jul’21. There is a shift now in the aim of monetary policy which has shifted from catalyzing recovery from COVID19-shock toward sustaining economic growth; output gap is now being forecasted at mildly positive level of +0.1% for FY22. It was also reflected by the strong pick-up in imports and a rise in current account deficit, which could begin to manifest in inflation readings based on higher imported inflation. Also, pronounced worries on account of the virulent delta variant of COVID19 prevailed in the previous MPC meeting; however, owing to the apt handling of authorities, the positivity rate and deaths have been largely contained. This decision was also underpinned by the movement in exchange rate from the rising current account pressures, where the adjustment of Rs/US$ parity as the first line of defence has been marshalled and it may likely transmit to inflation readings if policy rate is not used for support. Needless to say, this move by SBP does not suppress any underlying trend and the FX market may continue to face interventions on disorderly market conditions.

Exchange rate has adjusted along with rise in Current Account Deficit: Historically, the exchange rate adjustment in Pakistan has come forth after the CAD pressures ballooned to a sizeable extent but this time around the exchange rate has moved along with the increase in CAD. Even though, after the political development in Afghanistan, the financial buffers had tightened, but there has been no deterioration as such. The reserve buffer is at an all-time high level where gross reserves stand at a record US$20bn. Moreover, this has increased the Net International Reserves (NIR) by US$16bn since Jun-2019 till date. This jump in NIR is qualitatively giving Pakistan an insurance over the deterioration in CAD. While the situation in Afghanistan is very fluid and rapidly evolving, it seems too early to decipher the extent of implications on Pakistan’s economy. SBP is closely monitoring the foreign exchange market, cash market and moneychangers in the formal and informal sectors and the border areas. The movement in the Rs/US$ parity is not surprising as it is normal for the currency to move in different directions and should not cause enough worries over the longer horizon.

Pakistan’s fiscal management has improved but needs monitoring ahead: The fiscal measures have been appropriately targeted by authorities to deliver fiscal consolidation and favourable outcomes on public debt. Pakistan has been able to keep a very tight lid on debt growth which is much lower compared to global averages. Better fiscal consolidation during FY21 has helped to contain the primary deficit to 1.4% of GDP. Authorities need to closely monitor fiscal outturns to ensure the consolidation of budget, going forward, as expenditure growth is faster in FY22 and income tax and petroleum levy will be key to continue the budgeted consolidation.

What’s ahead? SBP and other authorities are in deliberations with the Fund on three core areas i.e. monetary, fiscal and energy (power). Primary issues have come up on the fiscal and power side where fiscal reforms are under discussion and concrete progress will be visible soon. Pakistan has historically witnessed a huge magnitude of change in policy rate where the hikes were pronounced and abrupt. SBP’s forward guidance suggests that the policy changes will not likely be abrupt this time and this ensures investor confidence remains intact. SBP has signalled the lifting of monetary easing and this move, in the context of faster pace than anticipated demand growth, puts it quite promptly as another two month delay may not only make it a moderate but also take away the measured and gradual change from it. Real rates will remain negative in the near term, however, future gradual hike will largely depend on the movement of gradual economy recovery; GDP growth for FY22 is now being targeted at the upper end of forecast range of 4-5%.