Discount rate maintained at 12.5%
Our expectations remained largely on-track in projecting a status-quo in the discount rate for the next two months. Financial markets broadly expected discount rate to remain unchanged since no dramatic movement was witnessed in market interest rates. We believe that central bank’s actions remain in line with its outlook on key risks and improvements in the economy so far, and would continue to have a cautious approach in managing expectations going forward.
Key risks highlighted in MPS
According to Monetary Policy Statement, the following key risks facing the economy were reason to avoid easing of interest rates.
· Despite lowering of inflation to 10.5% in Dec’09, structural obstacles in supply of food items, upward adjustments in energy tariffs and incipient international commodity prices increases make an uptick in inflation during Jan-Jul’10 highly likely.
· Prevailing energy crises and deteriorating law & order conditions in the country have substantially reduced economy’s productive capacity.
· Although agricultural sector has shown signs of robust growth, the likely shortfall in water availability during the remainder of year could affect agricultural productivity.
· Higher security expenses, uncertainty over foreign support and dismal revenue collection have constrained fiscal management. Based on current trend, meeting the fiscal deficit target of PKR740billion seems unlikely.
· Despite spike in total deposits on banking sector, liquidity in the system remains constrained. Based on substantial outstanding amounts to the government for commodity operations, continuation of credit utilization by Public Sector Enterprises and scheduled outflow due to PIB (PKR30billion) and T-bills (PKR430billion) auction targets, significant constraint on banking sector resources will remain.
· Based on projected growth in NDA and realization of external inflows, monetary expansion is projected to grow by 14.5% in FY10
· Decline in Current Account and Trade Deficit coupled with strong remittance inflows are positive developments in external sector. However, rise in imports, delays in maturity of FoDP support and repayment of IMF’s budget financing (~USD750million) could worsen improvements in external accounts.
· Gradual deregulation of exchange rate including the transfer of oil payments to inter-bank market has caused PKR to depreciate by 3.6% during Jul-Dec’09 and increased the incident of volatility. Further depreciation could augment efficiency of markets and boost competitiveness of exports; it could also add to inflationary expectations as cost of imports increases.
Cautious approach to continue
According to Monetary Policy Statement, the following key risks facing the economy were reason to avoid easing of interest rates.
· Despite lowering of inflation to 10.5% in Dec’09, structural obstacles in supply of food items, upward adjustments in energy tariffs and incipient international commodity prices increases make an uptick in inflation during Jan-Jul’10 highly likely.
· Prevailing energy crises and deteriorating law & order conditions in the country have substantially reduced economy’s productive capacity.
· Although agricultural sector has shown signs of robust growth, the likely shortfall in water availability during the remainder of year could affect agricultural productivity.
· Higher security expenses, uncertainty over foreign support and dismal revenue collection have constrained fiscal management. Based on current trend, meeting the fiscal deficit target of PKR740billion seems unlikely.
· Despite spike in total deposits on banking sector, liquidity in the system remains constrained. Based on substantial outstanding amounts to the government for commodity operations, continuation of credit utilization by Public Sector Enterprises and scheduled outflow due to PIB (PKR30billion) and T-bills (PKR430billion) auction targets, significant constraint on banking sector resources will remain.
· Based on projected growth in NDA and realization of external inflows, monetary expansion is projected to grow by 14.5% in FY10
· Decline in Current Account and Trade Deficit coupled with strong remittance inflows are positive developments in external sector. However, rise in imports, delays in maturity of FoDP support and repayment of IMF’s budget financing (~USD750million) could worsen improvements in external accounts.
· Gradual deregulation of exchange rate including the transfer of oil payments to inter-bank market has caused PKR to depreciate by 3.6% during Jul-Dec’09 and increased the incident of volatility. Further depreciation could augment efficiency of markets and boost competitiveness of exports; it could also add to inflationary expectations as cost of imports increases.
Cautious approach to continue
Mending macroeconomic conditions have provided breathing space to economic managers in the short term; upcoming prospects for the economy remain challenging. Headline inflation remains the prime concern for SBP and under current situation CPI inflation could continue to rise. Our forecast for average inflation in FY10 is ~12%, which is in line with SBP’s projections. Moreover, political uncertainty, precarious fiscal position, deteriorating liquidity and vulnerability to another international commodity price surge add to difficulties of managing domestic monetary framework. In our view, the central bank will not have room to judiciously lower the discount rate during the remainder of the year.
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