Karachi: The SBP has surprised the market with a 150bps cut in the policy discount rate to 12% (against street expectations of a 50bps-lOU bps cut).
According to AKD Securities, the sharp rate cut is due to 1) expected average CPI of 12% in FY12, in-line with the GOP’s target owing to the change of CPI base and methodology, 2) containment of GOP borrowing from SBP (net retirement FYTD) and 3) a comfortable external account, albeit one that requires vigilance. While private sector credit off-take should see some impetus going forward, AKD Securities see the GOP as the biggest beneficiary considering inflated domestic debt servicing was adding to pressure on an already bloated fiscal deficit. In AKD’s view, a rerating rally to price in the above-expected rate cut has the potential to take the KSE- IOU Index to 12.500 points in the immediate term. AKD’s preferred picks include NML, ENGRO, FFC, LUCK, DGKC, POL, PSO, PTC, KAPCO, MCB and UBL. However, selected cash-rich companies (e.g. Autos & Agri Autos) may potentially see a dip in other operating income’. Going forward, macroeconomic risks remain from a medium-term perspective where, with IMF SBA repayments commencing from Feb’12, foreign exchange reserves and consequently the PKR are expected to come under pressure particularly if domestic price pressures pick pace again.
Dovish monetary policy: With Sep’11 CPI clocking in at 10.46% (average 1 OFY1 2 CR of 11.48%) and expectations of a further dip in price pressure in the near-term, the SBP has reduced the benchmark discount rate by 150bps to 12%. This quantum of rate cut was last seen in late CYO2 when the DR was cut from 9% to 7.5%. Besides lower CPI (partly due to rebasing/chg. In methodology), the SBP’s decision to cut the DR to 12% was influenced by a reduction in GOP borrowing from the central bank (net retirement of PKR15Obn+ in last two months) and a need to spur both private sector credit off-take and GOP growth.
150 bps justified? Even at a 1%MoM increase, YoY CPI should remain benign (<11%) until Nov11. However, even with rebasing, continued
1%MoM increase in inflation will lead CPI to exceed 13% by Feb’12 which may stall the easing process. That said, considering Ramadan/flood- induced pressures should abate soon, the pace of sequential price increases should come off. While the GOP appears to be the biggest beneficiary of the steep rate cut (domestic debt financing accounted for 25% of the FY12 Budget), potential pressure on the PKR may make foreign debt repayments more expensive. In addition, with reserves slippage likely going forward (IMF SBA repayments commence in Feb’12), monetary easing does not take away from the importance of continued fiscal reforms.
Bull run at the KSE: Considering that the KSE-100 Index had priced in a rate cut of 75bps-lOObps, the 150bps cut in DR over the weekend has spurred bullish momentum with the Index up 2.5%. The KSE continues to trade at an attractive FY12F PER of 6.5x where expected continued monetary easing has the potential to take the Index to 12,500 points in the immediate term and to 13250+ points by Jun’12. AKD’s preferred picks include NML, ENGRO, FFC, LUCK, DGKC, POL, PSO, PTC, KAPCO, MCB and UBL. While AKD Securities remains cognizant of medium-term risks emanating from aggressive monetary easing, thawing US-Pak relations and talks with China for a currency swap agreement should further cheer the market.