The times they are a-changing!

Times are fluid. Global markets are reacting fast to COVAD-19.  The oil war has started with prices crashed around 20-30 percent yesterday – highest since 1991. It’s too early to say that where things might settle. There is a case of abrupt fall in global growth – pressure is from demand side. That is explaining steep slide in commodity prices. The impact is adverse for net exporting countries (especially oil and other commodities) while it is net positive for economies such as Pakistan which are net importers.

Bond yields in Pakistan are falling. It’s down by 19-41 bps yesterday across all tenures. Intraday volatility was higher. At one point the fall was 60 bps in 10y paper. There were talks of further slide as no seller was in the market with everyone on the buying counter. The currency in first half fell by 2.33 to Rs156.58. In the second half portfolio investors from UK started offloading T-Bills. The currency in tom market fell further and the bond yields moved up a little. In short, the expectations of rate that were previously set at 100 bps decline, by evening probably settled at 50 bps for the monetary policy review scheduled for March 17^th, next week.

The outflow from SCRA (in T-Bills) could well be in $250-400 million range. The expected inflows were less too. Exporters are lately selling dollars in forward market. This was below normal yesterday. Some panic was created by havoc in stock market early in the morning. Market was halted by 45 minutes. It was an unusual day.

Investors from US may cut their portfolio size in T-Bills today. Outflow may continue till things settle down in international markets. Currency may remain under pressure. Having said that, lower oil prices is a blessing for Pakistani market. If oil prices were to average at $40 per barrel during next 12 months, the current account savings would be significant. According to Topline calculations, $20/barrel low oil prices can reduce CAD to half - $2.2-2.8 billion. This could be more than enough to offset portfolio flows in terms of overall reserves.

There are potential savings on the fiscal side as well. There will be enough room for government to not only reduce petroleum prices but also to increase revenues by imposing higher petroleum levy. This will help in resolving energy mess. Negotiations with the IMF are already underway on how to reduce circular debt without increasing energy tariffs. Government can use part of fuel price adjustment in settling circular debt. It is the best time to resolve energy inefficiencies and high generation cost (including capacity payments) issues. The breathing space may finally be available.

Inflation outlook is improving. Commodity prices are falling. March inflation is already expected in single digit. The monthly inflation is down by 1.04 percent in Feb-20 and based on weekly SPI numbers (3 weeks out of 4 for consideration of March CPI) along with downward revision in petroleum prices, March monthly inflation would well be in negative. April could be in negative too despite house rent revision and upward spiral in food prices in anticipation of Ramazan.

A consecutive three months decline (Feb-Apr), the overall outlook of inflation shall improve. It may average around 9-10 percent in next 6-9 months. SBP has yet to release its FY21 inflation projections. One can bet on the forecast of 9-10 percent. That will give room to lower interest rates by 300 bps in next four quarters.

However, it’s not advisable to go for a kill. The currency may come under pressure if major rate cuts take place in a short span of time. There is significant conversion of foreign currency to PKR both by foreign investors and local retail investors. Back of the envelope calculations suggest that $3-4 billion is converted to PKR from domestic market. One may call it domestic (not too) hot money. Unlike foreign hot money, this may stick around. The underline credit risk of the country is probably improving given the commodity price fiasco. The foreign money is pulling out on world view. It’s across the board from east to west.

Other point is that the credit risk of the country has not improved enough to risk the nascent external account recovery by taking aggressive stance in the coming MPC review. A good option could be to cut rates by 50 bps next week. Wait for oil prices low to become a new norm and let the inflation numbers to come down to cement better outlook.