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Morning Briefing for November 30, 2011 – Standard Capital

Karachi: Discount rate will be slashed given sluggish economic indicators

There is a strong probability that State Bank of Pakistan (SBP) shall further decrease interest rates from present level of 12%.

According to Standard Capital, Standard Capital has already indicated that interest rates can come to a level of 10% (in 5‐6months) just to spur growth in the private sector. The reasons why Standard Capital trumpets this opinion include:

• Pakistan economy can come out of difficult phase if businesses get reprieve in shape of expansionary monetary stance rather than continuing phase of contraction that had brought major indicators at peril; new economic direction will rejuvenate confidence and spur real economic indicators;

• Present political set up may wish to improve economic health of trade and industry before the advent of next general elections; hence a reprieve in interest rates is on the cards;

• Influence of ministry of finance (MoF) over arbitrary decision making of SBP;

• CPI is relegating to nearly 11% (even though too much focus on keeping interest rates pegged with rampant CPI is considered flawed in case of a developing economy like Pakistan).

Pakistan could not meet major demands of IMF such as trade deficit, inflation, tax revenue etc mainly due to poor governance (when it was a recipient of nearly US$7bn during 2008‐2009 to support balance of payment and exchange rate). The program provided cushion to forex reserves to nearly US$ 17bn yet real economy deteriorated. Poor government machinery, lack of vision on trade and industry, political expediencies could be cited as some reasons why Pakistan is performing poorly in real sectors.

Pakistan compromised on matters such as reforms, privatization, industrial vision, economic integration with regional countries etc. Fact of the matter is that only supply side policies could spur real sector indicators and hence marginalize fiscal deficit as well as free fall of rupee. This view support probable decrease in interest rates to nearly 10% in 5‐6 months since now government should pursue growth vision.

Pakistan tried to re‐negotiate with IMF just to get cushion on deteriorating balance of payment as well as exchange rate since real economy (agriculture and industry) went to the bottom pit. However, talks remained inconclusive since Pakistani federal and provincial machinery is incapacitated and cannot improve indicators. For instance inter‐corporate debt of nearly Rs 400bn has mocked energy sector, resulting in severe load shedding thus hurting real sectors. Secondly, bad management in state enterprises is eating government coffers thus there is no development spending coming.

Government over borrowed from SBP to meet budget deficit due to lack of reforms on tax revenue front. The crowding out affect has kept interest rates at a higher rate and hence economic sectors suffered. We see government had no option but to give rare positive signal to businesses and potential investors in order to rejuvenate various sectors. The policy of pegging inflation with interest rates does not serve the purpose rather controlling inflation is very much an administrative function of the federal and provincial governments.

We expect gradual cuts for instance 50bps in today’s Monetary Policy Statement (MPS) since MoF would like to enforce government’s agenda of spurring growth in at least last year of President Zardari government.

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