Monetary Policy There are talks of a rate hike; but we expect status quo

Event

• State Bank of Pakistan (SBP) will announce its monetary policy for the next two months in the upcoming review meeting on Friday.

There are talks of a rate hike

• There are talks of a possible interest rate hike due to the following:

• A spike in headline inflation. Headline inflation has accelerated, increasing to 12.3%YoY, 30bp above SBP discount rate, in May. The upside pressures could continue in the next two months due to advent of Ramadan which is preceded by a sharp uptick in food prices.

• A weakening external account position. The external account position has significantly weakened during FY12 with July-April current balance posting a deficit of USD3.4bn. Further, due to weaker financial inflows, overall balance recorded a deficit of USD2.5bn during the same period. For full fiscal year, government expects current account deficit to hit USD4.0bn. Further, the government expects external sector weakness to continue in FY13 as well as depicted by its FY13 current account deficit forecasts of USD4.8bn.

• Declining PKR. In a manifestation of weakening BOP position, PKR has depreciated by 4% against USD in the last one month. The above would also ignite inflationary pressures due to higher prices of imported prices.

• Widening fiscal deficit and SBP borrowing. FY12 fiscal deficit is now estimated at Rs1521bn (7.4% of GDP). Budget deficit financing mix also remains undesirable with the government increasingly relying on SBP to fund its fiscal operations. So far, the government has borrowed over Rs400bn for budgetary support from SBP, which should create further demand-led inflationary pressures.

But we expect status quo

• However, we expect SBP to maintain status quo with our premise based on the following:

• Sharp decline in global commodity. During the last few weeks, global commodity prices, especially those of petroleum products, have been in a tailspin, declining by 20-22% from their recent peaks, on improving supplies and, more importantly, global meltdown fears. If the trend is sustained, it will significantly allay pressures on Pakistan’s twin deficits as every USD10/barrel decrease in oil prices, ceteris paribus, improves Pakistan’s current account balance by USD1.2-1.3bn. Further, lower FO prices would improve electricity generation cost and reduce power subsidies.

• Broad inflationary pressures remain in check. Notwithstanding a spike in headline inflation in May, the break-up reveals that it was caused by 1) 16% hike in electricity tariffs 2) 34% increase in text book prices. Excluding above, MoM inflation was up by just 0.21% as prices of other items remained largely stable

• Weak growth and low investments. Though GDP growth slightly accelerated to 3.7% in FY12, most of the large scale industries are still operating below 70% capacity. Further, private investment as % of GDP is estimated to have declined to an unprecedented 7.9% in FY12 from 8.6% last year. Thus, to spur economic activity and private sector investments, the central bank may choose to maintain status quo for now.

• CSF and other inflows. In a leap of faith, we expect SBP to wait for another two months for realization of planned foreign inflows (mainly CSF) which could mitigate BOP pressures for now.

(FS)

Monetary Policy There are talks of a rate hike; but we expect status quo