Grass is greener

The macroeconomic indicators are shaping well. The biggest relief is coming in the form of low inflation and falling inflationary expectations. Inflation was the biggest shock Pakistan’s economy faced in the past 6-7 year: Average yearly inflation in FY08-14 was 12 percent against 6.4 percent in FY00-08. The high inflationary era coupled with low growth had crippled the middle-class and disturbed the long-term equilibrium of the economy.
But inflation has been steadily coming down: In previous two years (FY13 & FY14), CPI inflation was down to single digits and the downward slope is steeped by more than expectation owing to sharp decline in global commodity prices, especially oil. That is why inflation in FY15 is expected to be around 6-6.5 percent (lowest in 10 years) against government’s target of 8 percent.
This is likely to boost consumers’ confidence in a few months as the behaviour changes with a lag. Stock market was already up by 3 percent in the last week, perhaps in jubilation of November CPI that came down to 3.96 percent – lowest since November 2003. The good omen is the real pick in daily stock volumes trade, which was 152 trading days high on Wednesday (423 mn shares).
This means serious business for brokers and nothing but expectations of lower interest rates is the prime reason for regenerating interest of investors in the KSE. The NSS rates were revised downward by 137-200 bps in the last week, which immediately tilted the investors towards stock market. Policy rate is likely to fall by 150-200 bps in coming few reviews. This is making dividend yields on stocks attractive than fixed-income instruments. The country’s changing economic variables have attracted local investors, as over last two consecutive weeks foreign players have been the net seller in the market.
If this high value in share trading ($148.9 mn average last week) persists, soon there will be an urge in brokerage and asset management industry to hire more professionals in research and trading desks, and prominent firms may start re-establishing regional sales offices here. Similarly, banks may like to strengthen their equity desks and may not continue to extract high rents from parking in government papers.
Nonetheless, 2014 was a heaven for bankers in Pakistan, as the ministry of finance, in its quest for improving maturity profile of domestic assets, has provided a feast for commercial banks to invest in PIBs. What can you ask more in days of falling interest rates to have the lion’s share of incremental investment in fixed-rate, long-term government papers at 2.5 percent premium to prevailing discount rate! And discount rate is expected to fall further.
But the government, after issuing Rs2 trillion of PIBs, is probably thinking that maturity profile has improved enough to the liking of the IMF. In the three-month period (Dec 2014-Feb 2015), the government is targeting to issue Rs150 billions of PIBs against the maturity of Rs200 billion. On the flip, for T-Bills, the target is Rs775 billions against the maturity of Rs502 billion. The yields are likely to fall even as inflationary expectations are likely to be low – and there is already a cut in NSS rates.
The additional borrowing requirement might not be as high as it was in the previous years – with the fall in oil prices, the subsidy burden may ease as well. The circular debt is likely to be subdued with international oil prices coming down as the cost of power production will be lower while the tariffs may remain sticky. But the benefit may be partially offset by lower GST collection on petroleum products including motor gasoline, diesel oil and furnace oil.
If the oil prices, on average, go down by 20 percent in FY15, the revenue loss on GST of petroleum products would be Rs60-70 billion while the cost of power production would be lower by Rs100 billion. It would be interesting to see how much this scenario would curtail subsidy element, for sooner or later, its impact has to reflect on tariffs in terms of fuel adjustment.
Nonetheless, fiscal deficit is going to be tamed and more importantly, with some privatisation flows and international bond issuances, the government’s reliance on banking system may be curtailed. The numbers are already showing the impact – government borrowing for budgetary financing from the banking sources has been Rs194 billion in fiscal-year-to-date as compared to Rs448 billion in the corresponding period last year.
Isn’t that great? Yes, but its impact of “crowding in” private investment is little to none. Credit to the private sector has shrunk so far this year, by less than a half, to Rs58 billion. That makes the call for bringing interest rates down compelling: How can corporate borrow decent amount with real interest rates (discount rate minus full-year expected inflation) at 3 percent?
The cautious optimism is warranted in monetary policy stance to curb the balance of payment vulnerabilities. But there is no immediate threat as the falling commodity prices’ impact will curb imports more than the dent on exports. A 20 percent fall in oil prices may lower the oil import bill by $2-2.5 billion (adjusting for elasticity in demand) while lower cotton and rice prices may hit exports with less proportion. If oil prices settle at $80 per barrel in FY16, the current account may enter surplus-zone as agri commodity prices’ cycle may reverse with next crop (9-12 months). Hence, the need of lower interest rates is profound.