Despite a cautious monetary policy tone, the State Bank of Pakistan (SBP) has once again attempted to shake the economy out of the low growth – relatively high inflationary environment by lowering the key policy discount rate (DR) by 150bps to 10.5% for the next two months.
The quantum of the rate cut in the monetary policy is, however, 50bps higher than the upper band of market consensus estimates. With regards to the latest rate cut, we think the SBP is becoming more concerned about subdued private sector credit and investment, and is less worried about the downside risks to the PkR. That being said, room for an accommodative monetary policy stance has been provided by moderating inflation and easing constraints on the fiscal and external front, although at the margin.
In particular, soft CPI statistic for the month of Jul’12 (9.6%) and the recently received US$1.18bn in Coalition Support Funds (CSF) together interlaced market expectations for a decline in the DR. The recent decline in secondary market yields also signaled the peaking of borrowing costs, in our view. Going forward, the continuation of an accommodative monetary policy stance would depend on softening price pressures and the government’s adherence to effectively implement much needed structural reforms.
However, risks exist in form of 1) exchange rate stability, 2) materialization of projected external inflows, 3) core CPI has remained firm, 4) chronic power shortages and 5) unabated domestic borrowings to plug fiscal slippages, in our view. From the KSE’s perspective, the latest cut in the discount rate should drive vibrancy in the market with the benchmark KSE-100 Index expected to test 15,500 levels. In this regard, although valuations should re-rate across the board for the KSE, we flag leveraged sectors (cements, selected fertilizers and textiles) as the prime beneficiaries of a moderate interest rate environment.