The State Bank of Pakistan (SBP) is scheduled to announce the Jun’12-Jul’12 monetary policy on Jun 08 ’12. While the latest CPI unexpectedly rose higher (up 1.15%MoM) in May’12, we believe current positive real interest rates (100bps), an anticipated slow down in global commodity prices and lack of clarity on the external front should, in our view, encourage SBP to stay on the fence and maintain status quo on rates (base case) during its monetary policy review for the subsequent two months. Within this backdrop, we are also of the opinion that the policy discount rate has bottomed out and upside risks to interest rates exist in the form of 1) delay in materialization of targeted inflows, 2) exchange rate stability (PkR has depreciated by 4.3%CYTD vs. the USD) and consequent risk of imported inflation, and 3) unabated government borrowing from domestic sources (leading to further deterioration of the NDA/NFA ratio). From the market’s perspective, the KSE‐100 Index trades at a forward PER of 6.0x and offers an attractive forward dividend yield of 7.48%. The earnings yield for the Pakistan Market is at 16.6% compared to the weighted average 1 year T bill yield at 11.95%. At current valuations, we recommend exposure in Banks, Oil & Gas, Cements and selected Chemicals.
Auction trend inference
About 99% funds on average are being parked in the shorter term 3M (84%) and 6M (15%) tenors since the last monetary policy, indicating that money market participants are anticipating higher yields going forward. However, while participation has been restricted into shorter term tenors, cutoff yields have not followed inflationary expectations and have instead remained largely unchanged since Apr ’12. While we believe that interest rates have bottomed out and despite money market anticipating higher yields, we do not expect a rate hike in Jun’12.
Risks and Outlook While average CPI should clock in around 11% in FY12, the GoP projects CPI to be 9.5% for FY13. In this regard, while weaker international oil prices should provide comfort on the external front, an unabated trend of government borrowing (government borrowings for budgetary support have been PkR695bn from the scheduled banks and PkR402bn from the SBP FYTD), higher food prices and PkR weakness can keep CPI from breaching below 10% going forward. Additionally, stubborn domestic POL and electricity prices and hike in crop support prices (election year) can stoke inflation in the near to medium term. Pressure on the reserves has risen off late due to low materialization of projected foreign inflows coupled with upcoming debt repayments (IMF and Paris Club). This has also placed considerable pressure on the PkR which is down 4.3%CYTD vs. the USD and is a key risk going forward. Excess capacities available in the industry due to an unresolved energy shortage situation are also weighing down the economy. In such a scenario, a return to the IMF cannot be ruled out in FY13 and the critical Pak‐US relation is a key check point to track.
(BCPL)
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