In line with general expectations, State Bank of Pakistan (SBP) has reduced the discount rate by 50bps to 8%. The SBP’s decision to continue with its on-going monetary easing stance received support from improving macroeconomic indicators that include: 1) considerable slowdown in headline inflation average to 5.47% during first eight months of current financial year, 2) sustained strength in the external account with current account deficit declining by 34.2%YoY to US$1.6 billion and 3) foreign exchange reserves at a comfortable level of at US$16.2 billion.
With this cut, the discount rate has now come to a level that was last seen in March FY05. During the same period the KSE-100 Index was trading at a P/E of 12.7x. This reduction in the policy rate is likely to act as a catalyst for the market which has been going through a correction phase where the market’s P/E came down from 9.1x to current 8.5x. In addition to this, the KSE-100’s discount to its regional and MSCI Asia (Ex-JP) peers went up to 31% from recent 27%.
A 50bps cut in the policy rate is the third sequential reduction since the onset of monetary easing cycle in November last year. The SBP’s move was supported by recent macroeconomic stability with key themes. In addition to this, with expected slump in global commodity prices to continue, the SBP also revised its forecast for FY15 CPI to hover between 4% to 5% inflation to 4% to 5.0%YoY.
SBP’s dovish action is expected to prove beneficial in reviving the private sector credit cycle, which has remained subdued. Credit growth reported at 7.3% in January this year was much lower than 11%YoY increase witnessed at end FY14, as banks continued to put money in government securities (banks’ holding of PIBs was nearly 70% in February this year.
The lagged effect of the last as well as the current rate slash can re-trigger credit off-take over the medium term, as banks shift from PIBs as yields are expected to decline further in upcoming auctions.
While financial impact of the latest rate cut looks marginal, the move is likely to provide a much needed impetus to the overall investors’ sentiment and lead to greater participation at the bourses.