Monetary policy: Status quo is the way to go

After lowering the policy rate by 400 bps and discount rate by 350 bps between Nov14 and Sep15; the policy rate was kept unchanged in November 2015 and January 2016 reviews at 6 percent. The question is that whether the easing cycle has bottomed out or SBP may go for further lowering interest rates in its monetary policy announcement tomorrow.

The market expects status quo to maintain. Out of 14 research houses contacted by BR Research 12 opine status quo, while two are for a rate cut of 25 bps. The trend in secondary market yields of government papers suggests that market is expecting no change in the interest rates. The recent pickup in consumer price index also indicates that a cautious stance is warranted, according to market participants. Although, the food price remained suppressed in past few months which may encourage dovish group in monetary policy committee to push for an easing agenda.

The minutes released from last policy review revealed that 2 out of 8 members voted for the rate cut while the rest were proponent of no change. The model based forecast presented by SBP’s research department also suggested a rate cut. The dovish clan argument was based on the soft inflationary expectations despite the recent up tick in CPI. They opined that there is still much room left to boost private credit through monetary policy easing.

While the hawks dominated the decision as according to them, by taking a long term view of economic trends, the need is to maintain stability in order to encourage prevailing trends to be fully embedded. They argued for cautious stance to counter the possible reversal in oil prices downward trend. And most importantly, the foreign exchange market considerations are paramount for not easing MPS any further.

BR Research believes that the easing cycle is bottomed out and it’s time to wait and see and let the previous easing to fully transmit into the monetary system. It is correct that private sector credit by no means is close to its potential but lowering interest rates is not the only answer for subdued growth. The government borrowing from the banking system and overvalued currency are still challenging the long term economic stability.

The need is to have a balanced approach in economic policymaking. There is no rationale for too much easing of the interest rates when the foreign reserve building is based on loans and aid. Keeping both concessionary interest rates and exchange rate policies is a dangerous mix for an economy which has a history of balance of payment crises.

The banking system is finding it difficult to provide ample liquidity for fiscal needs and the SBP is continuously pumping money into the system. The OMO injections have crossed Rs1.5 trillion and it is alarming to continue relying on this tool for too long.

The broad money grew by 5.27 percent in this fiscal year so far as against 4.95 percent in the similar period last year. But the problem is in its constituents. The currency in circulation has almost doubled in the first nine months of this fiscal year while the banking deposits growth is restricted to half. High pace of money going out the system is a problem and that has to be addressed. This has diluted the impact of higher growth in net domestic assets. The NDA grew by Rs481 billion (4.6%) this year so far versus Rs362 billion (3.86%) in the similar period last year. The monetary policy easing is increasing the NDA but money creation element from commercial banks is limited. The net foreign assets growth was encouraging in the first quarter but its slowdown in the second and third quarter is not encouraging for monetary easing mantra. The private sector credit almost doubled in the fiscal year so far which is implying that easing cycle is doing its trick.

But that is not enough. Is lack of monetary easing the reason for not too high private sector credit? Is the monetary easing truly for the corporate credit to expand? Well, SBP’s stance in private probably is different. There are reports that SBP is stopping commercial banks from back doors to lend to private sector for power projects. The central bank fears that if domestic money is used for power infrastructure expansion the balance of payment problems can arise as the majority of loan would be used for importing plant and machinery which could worsen the current account balance. The central bank is urging private sector to pursue foreign funding for its domestic projects.

By having such philosophy there is no rationale for further easing in monetary policy. Is this for mere lowering cost of government borrowing at cost of risking balance of payment crisis? The risk is not worth taking. Plus, the government is supporting export sector through other measures such as adequate gas supply to textile sector which has considerably lowered their power generation cost. The long term financing for textile companies is available at 2.5 percent. The SBP is providing banks financing for LTF at 2 percent and banks are lending to them at meager margin of 50 bps. This leaves only political mileage to gain from further easing in the monetary policy. The latest tax collection numbers are encouraging as in nine months FBR reputedly collected Rs2.1 trillion exhibiting a growth of 19.7 percent over the corresponding period last year. The numbers have surpassed targets and may lower the need of fiscal borrowing from commercial banks and that may entice SBP a rate cut.

However, it’s not advisable to do so. Balance of payment considerations should restrain SBP from further easing. The oil prices can reverse in second half of 2016 which could put pressure on currency and inflationary expectation can resurge. To counter it, the doctor’s order is to keep the interest rates unchanged and may start increasing it in the second half of the calendar year.

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BR Research Monetary Policy Survey


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MPS date    No of     Outlook            Rationale cited on consensus basis                     Decision


          respondents                    The treasury market yeilds of late are


                                         pointing towarrds status quo as they


                                         have not moved significantly. CPI may


                                         pick up in the coming months. Banking


                                         sector credit has not gone up the roof


                      2 = 25 bps cut     despite steep cut, so there is no


Apr-16        14      12 = Status quo    rationale for cutting further. Paksitan has            Awaited


                                         over $5bn payments to IMF and other


                                         bilateral institutions coming up, which would


                                         keep pressure on reserves. Those seeing a


                                         cut say CPI will be well below the target


                                         and the real interest rate ffers a room


                                         to cut the rate further.


                                         There is room avialable but CPI may well


                                         have bottomed out, which is why the


                                         rates should remain intact. Treasury market


                      4 = 50bps cut      auctions also signal a continuation


Jan-16        20      16 = Status quo    of prervious rate. Those seeing a rate                 Status quo


                                         cut opine that reserves are


                                         strengthening, oil prices are tanking and


                                         the impact is yet to be translated to


                                         CPI, plus real interest rate offers


                                         enough room for a cut.


                                         Latest PIB auction and the declining yeilds


                                         cited as the mian reason for a rate cut.


                                         Those in favour of status quo believe that


                      5 = 50bps cut      the CPI has bottomed out and


Nov-15        19      14 = Status quo    the fiscal space and SBP's previous actions            Status quo


                                         tell that rates will remain where


                                         they are. Another reason cited is that the


                                         positive real interest rate is not sustainable.


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