The much-awaited monetary policy announcement is expected this week. Punters are betting on a rate cut, while most analysts have opted for ‘no change’. The rumor mill started from ministry of finance office that there is an agreement with the IMF of having real interest rates of 125 bps on the expected inflation – and that gives a room of 25-50 bps cut. They probably are living in a hangover of Dar regime where government used to make calls on MPS; while the SBP seems to be independent now.
There are merits and demerits of rate cut. There was little rationale, apart from curbing speculation, for cumulative increase of policy rate by 250 bps in May and July along with steep currency adjustments. However, by cutting rates too early, the SBP may risk losing its regained credibility. And the market rates are already down - thanks to resistance of MoF debt office against the greed of banks, the costs of both government and private sector borrowing are already declining. Any token decline will primarily pump more blood in the booming stock market, rather than having an immediate real impact on the economy.
Short term rate hike is not a big issue, and was overhyped; the main problem was of higher long term rates. Back in 2014, when the discount rate peaked at 10 percent, Rs 2.2 trillion of PIBs were issued between Jan14-Oct14 at cut off yields ranging from 12.1 to 13.5 percent, and the higher debt services cost the government had to incur even when discount rate came down to 6.25 percent (policy rate: 5.75%).
Recently, between May19-Aug19 when rates were peaking, the government accepted Rs999 billion at cut-off yields ranging from 13.15 to 14.25 percent while the policy rate was earlier 12.25 and then increased to 13.25 percent. Thereafter, despite having discount rate (13.75% post Jul-19) at its multiyear peak, the government started accepting lesser amounts to lower the yields – between Sep19 to Nov-19, government accepted Rs412 billion with yield ranging between 11.35 to 12.95 percent. The greed of banks got converted into fear. Now the 10-year paper secondary market yield is at 11.32 percent.
Those who argue that higher policy rate costs higher fiscal borrowing, have to see broader contour. The short term rates do not matter much as the cost comes down as fast as the policy or market rates are down, while having higher quantum of long term bonds at higher rates bites for long.
The second argument in defense of lowering rates is the heightened cost of private sector borrowing –linked to KIBOR. Yes, that is true; but not the sole reason for sharp economic slowdown since the dawn of this fiscal year. The monetary policy impacts with a lag as loans are usually repriced after 3-6 months, and more importantly, most of Pakistan businesses are not highly leveraged, and the consumer finance is minuscule – confined mainly to the auto sector.
The counter argument offered is that if the businesses and consumption are not leveraged, why increase rates to compress demand. That is true as well, but it does not mean that higher rates are killing economy today. The prime reason for recent slowdown is linked more to documentation efforts than anything else.
The higher cost is associated with government where around two third of banking credit lies. The cost relative to policy rate is lowering versus 2014. What is the push behind rate cut lately? It could be about the stock market where brokers are selling ‘tezi’ in anticipation of rate cut. It seems about the opportunity cost of the money, and better valuation based on higher future earnings, if rate comes down in November.
On the flip, according to CFA Society survey, 91 percent of respondents expect no change, while the remaining forecast 25-50 bps cut. In response to a question on when would monetary easing start, 32 percent think in Mar-20, while 47 percent think in May-20 or beyond.
The real question is what would be the SBP thinking and what is in the mind of MPC members. Governor SBP, a few months back said to analysts that central bankers are like ocean liners and they take time to change direction. With such aggressive tightening stance in May-19 and Jul-19, and after indicating that tightening cycle has possibly ended end in Jul-19, the SBP may have a pause for a few reviews, before starting easing cycle.
Another way of looking is to see the trend in real interest rates. Historically, real interest rates have been kept at 200-300 bps on expected inflation, and at this point, the rates at 100-200 bps of expected inflation. Thus, SBP might be thinking that there is some relaxation on rates based on history for private sector, so the need of cut in Nov-19 is uncalled for.
The third element is higher month-on-month inflation in Oct-19, and Governor might be looking at monthly numbers with keen interest. The headline inflation is north of 11 percent, and SBP forecast is 11-12 percent, and inflation targeting is the foremost objective of SBP, and Governor is clear on looking at headline numbers, not core inflation which is lower. The seasonal hike in tomato, onion and chicken prices are somehow driving monetary policy.
The SBP usually shares its model based projections and other documents with policy members a night before the meeting and then the agenda is deliberated in the meeting, and finally decision is taken based on what is fed and what are the independent view of the members, In the last policy meeting, it was the first time since Sep17, that a member voted for 25 bps cut while the remaining 8 were for no change. This time there might be more voices for rate cut, but the majority may go for no change.