MPS: Slowdown bottoming out?

Policy rate has remained unchanged, in line with expectations (read, ’Rising inflation: put rate cut on halt’, published on Monday 27 January, 2020). SBP has not altered its inflation outlook and has deemed food prices hike a blip. The medium-term inflation target is 5-7 percent for the next 6 to 8 quarters. Monetary policy will continue to focus on this target. Market expects easing cycle to start by Jul-Sep 20.

SBP’s pulse reading of the economy is that the slowdown has bottomed out. LSM has recorded contraction for five consecutive quarters, but gradual recovery is expected in coming months. The decline is in sectors catering to domestic demand (inward looking) while increase is in exporting and import-competitive industries.

Interestingly, value addition in textile is not reflected in LSM. Textile is 20 percent of LSM or 2 percent of GDP. Value addition up to cotton cloth is recorded in LSM. Pakistan computes GDP by production method, and textile is a subset of LSM. Value-addition in textiles is not clearly reflected.  Readymade garments, bed wear and knitwear constituted 57 percent of textile exports proceeds in 1HFY20. The volumetric growth is 32 percent in garments, 12 percent in bed wear, and 6 percent in knitwear.

SBP has enhanced its subsidized credit limits to exporters: both for working capital and long-term investment needs, each by Rs100 billion. More significantly, per party LTFF limit has been doubled to Rs5 billion. The challenge is in expanding this to a wider range of firms and sectors, and to ensure no misuse. The next step is to bring higher incentive so firms may explore new markets and sectors.

SBP’s GDP growth projections are likely to be revised down from earlier 3-3.5 percent. Market average forecast is at 2.7 percent. Cotton crop has proved to be a big dampener. There should be some credit and policy support for homegrown certified cotton seed producing firms.

The dividend of aggressive tightening has come in the form of 75 percent reduction in current account deficit. Its primarily import compression. Volumetric growth has come in major exporting commodities and value-added products, but depressed prices are diluting numbers. There is a light pick up in remittances.

The competiveness dynamics are changing with exchange rate has adjusted closer to its real value. Flexible exchange rate regime and positive real interest rates attracted foreign portfolio investment in debt for the first time. The real interest rates were higher in the past. The differentiating factor is flexible exchange rate, indicated by gradual currency appreciation in the past few months.

But now with rising inflation differential, some are expecting currency depreciation. However, since the currency has moved some length (from Rs104/USD to Rs155/USD) in two years, the differential must be seen with this lens, especially because ongoing food inflation is expected to be a temporary phenomenon. Foreign currency supply in the market is in excess. Moreover, exporters are not showing signs that currency is losing competitiveness. There is no evidence of demand induced imports pick up. Thus, between the line message is that currency levels are in the right band.

This does not mean that SBP is not buying. Some say that $3 billion are being fetched from open market. Forward labilities are down by $4 billion. Netting addition to reserves and reduction in foreign liability, the net influx is around $8 billion this year. And while a lot of concern is raised around hot money, it is only 20-25 percent of the total flows.