The monetary policy is due today. Hike in market rates implies 175-200 bps increase in the policy rate. Prior to the previous policy decision (in Nov-21), market had priced in 100 bps increase. The policy decision surprised the market by higher-than-expected increase. This time around market can be surprised by lower-than-expected increase.
The surprise could be 100 bps (or less) hike. However, seeing the volatility, 100-150 bps cannot be ruled out. It’s a tough call to make. A prudent approach could be 50-100 bps along with some outright buying of government securities, and a clearer forward guidance.
Suddenly, market analysts and participants are all becoming hawks. They are eyeing headline (YoY) numbers for the next few months and seeing these in double digits, they are talking about similar policy rate. However, inflation in FY22 may hover around 9-11 percent and this could well be in single digit for FY23. The base has increased due to 2.1 percent, 1.9 percent and 3 percent monthly increases in the last three months. Market is clearly overreacting.
Recent global inflation numbers are surprising many. Last month’s number for US at 6.8 percent was forty years high. Germany’s wholesale inflation stood at 16.6 percent. The developed world is keeping near zero interest rates. SBP needs to evaluate inflation and interest rates differential and transitory nature of inflation to make a call on policy rate. The mildly positive rates should not be on the next few months. There should also be a consideration for medium-term inflation targeting of 5-7 percent.
Anyhow, the non-nominal anchor for monetary policy decision in Pakistan is the current account. Had the current account not been slipping, the response to higher inflation could have been milder. The deficit stood at $5.1 billion in the 4MFY22 and based on $5 billion trade deficit (PBS data), the current account number could be around $2.5 billion in Nov21.
That is the reason for not having a soft landing on moving from negative real rates to mildly positive real rates. It is time to entice dollar flows into the country. Higher interest rates make PKR attractive. Undervalued currency may do the same. The bet could be to attract debt portfolio flows in the government bonds/bills. That is the need of the hour.
One of the reasons for bullishness in the market is the recent T-Bill Auction. The cut-off yield for 3M paper was 10.79 percent and 11.5 percent for 6M paper. Even the treasures were not expecting this cut off. They were not expecting the government to accept that. Since, over around Rs2.6 trillion are maturing in the next two auctions, the government ought to grab these.
The FM is not happy on the rate hike. He played to the gallery by warning banks in media against bidding high rates. No one in Islamabad is happy with rising interest rates and depreciating currency. But these are required to bring current account in better shape. The CAD may well have peaked in November 2021, as imports likely to have peaked at $7.85 billion (based on PBS data).
There are some one-offs in the past few months – vaccine and TERF related imports. There are signs of some easing in the commodity prices since the peaks in October. However, all is moving back again from their recent low due to fear of new COVID variant. It is hard to say which way oil moves. However, this has a significant bearing on the current account deficit in Pakistan, and on the monetary policy.
The question is how much of tightening is enough to bring semblance to the current account and what rate hike would make markets lower the bids in upcoming T-Bill auctions. Another question is how much rate hike would bring dollar flows into the country. And then another question is what other steps can calm the higher rates bidding trend.
One point, as mentioned last week (Read “Fear & Greed: ‘if wishes were horses...”, published on 10th December 2021), is to go for outright purchase of government securities by SBP from the secondary market. That may calm market a bit. The other is to give the right direction. Market is uncertain and bearish on fundamentals. That is making them bullish on government papers.
SBP needs to revise up its inflation and current account deficits targets. 7-9 percent inflation in FY22 is outdated. With almost half the year gone, SBP should revise this up. That could anchor the direction of real rates. SBP must guide the market which is reading too much into the next few months inflation number (based on changing base in the last three months) and into high current imports. The leash could be a measured increase of 50-100 bps. And if the rate hike is higher, the endgame of tightening should be well communicated. Option one is better.
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