Pakistan’s central bank is likely to start cutting interest rates from March 2024, according to a report by analysts at a leading brokerage firm. This would be the first rate cut since June 2020, when the State Bank of Pakistan (SBP) slashed the policy rate by 100 basis points to 19% amid the COVID-19 pandemic.
The analysts based their forecast on the projection of a disinflation trend, which would make the real interest rates (RIR) positive in the first half of 2024.
The RIR is the difference between the nominal interest rate and the inflation rate. A positive RIR means that the interest rate is higher than the inflation rate, which implies a tight monetary policy stance.
A JS Global report said that the inflation trend has been relatively low in recent months, except for November 2023, when the gas price hike pushed the consumer price index (CPI) to 20.5%. The analysts expect the inflation to ease in the coming months, due to the high base effect and the gradual depreciation of the Pakistani rupee (PKR) against the US dollar.
The report projected the CPI to average 18% in 2024, down from 19.5% in 2023. It also assumed that the government would continue to increase the gas and electricity tariffs regularly, as part of its fiscal consolidation efforts.
The analysts expect the SBP to cut the policy rate by 100 basis points in March 2024, when the RIR would turn positive on a spot basis. They further expect the policy rate to decline to 18% by June 2024 and 15% by December 2024, as the inflation continues to moderate.
The report also said that the monetary easing cycle would be accompanied by a change in the shape of the yield curve, which has been inverted since April 2022. An inverted yield curve means that the short-term interest rates are higher than the long-term interest rates, which indicates a pessimistic outlook for the economy.
The analysts expect the yield curve to become upward sloping, as the yields of shorter tenor instruments fall faster than the yields of longer tenor bonds. They said that they did not change their basic cost of equity components (Risk free: 16%, Risk premium: 6%) used for their valuations, as they reflect the long-term equilibrium levels.
The report also noted that the secondary market has already started to anticipate a potential rate cut in the near future, as the yields across the tenors have dropped by 100 basis points since September 2023. The analysts said that they do not rule out the possibility of further downward movement in the secondary market yields, before the actual announcement by the SBP.
The report said that the impact of the interest rate cut would be most significant for the country’s fiscal accounts, as Pakistan’s mark-up expenses have reached 75% of its total revenue. The report estimated that every 100 basis point cut in the interest rate would reduce the expected fiscal deficit by Rs400 billion, or 0.4% of the gross domestic product (GDP).
However, the report said that the savings in the fiscal deficit for the fiscal year 2024 (FY24) would be relatively limited, as the rate cut is expected from March 2024. The report added that if the secondary markets adjust before the policy rate change by the SBP, the savings could be higher than their current base case.
The report also cautioned that the timing of the potential cuts in the global interest rates would be key for the exchange rate stability, as lower interest rates could tend to decrease the currency’s relative value. The report said that the PKR depreciation would have an impact on the prices of petroleum products and food items, which are major components of the CPI basket.
The report also analyzed the impact of the interest rate cut on the listed companies, and said that it would have diverging effects on different sectors and firms.
The report said that lower interest rates would affect the financing cost/income of the companies, but also have a lagged impact on the demand recovery over time. The report said that for their base case, they only incorporated the effect of the former, and the potential impact of the latter would be an addition to their projections.