In continuation with its monetary policy easing, State Bank of Pakistan (SBP) has announced first discount rate cut of FY16, reducing the rate to 6.5%. The central bank opted to reduce its key interest rate by 50bps primarily accommodating multi-years low inflation due to low international oil prices. Other factors driving the decision included: 1) favorable Balance of Payment outlook on remittance growth, 2) reduction in current account deficit, 3) healthy foreign exchange reserve accretion expected from Eurobond issue and disbursement of US$500 million by IMF due this month and 4) a positive policy tone centered around planned improvements in energy supplies, law and order situation and initiation of large scale infrastructure projects.
However, analysts fear that the central bank will be prompt in increasing the rate once international oil prices begin to move upwards assuming energy supplies remain sub optimal and private sector credit fails to pick up traction. In this regard, the current low interest rate levels are likely to be short-lived as inflation numbers start to pick up (base effect diminishes) from December this year, which would effectively squeeze real interest rates to below 100bps against the policy rate (currently at +3.3%) – prompting the possibility of a rate hike as early as 2HFY16. Hence, further rate cuts remain unlikely though monetary policy may remain dependent on global oil prices.
Following SBP’s decision, AKD Securities has revisit earnings projections for AKD Banking Universe where it has incorporate average discount rate of 7.25% for CY15 and 7.5% for CY16. For the Big-6 banks, this reduces CY15 earnings estimates by 1.8% on average and for CY16 by 3.1% on average. Within this backdrop, brokerage house believes banks have the capacity to compensate for tighter NIMs by pushing loan growth/booking capital gains. With monetary easing cycle expected to draw to a close and an anticipated improvement in loan growth (CPEC projects to come into play) it would become visible in CY16 and CY17, and retains its market-weight stance on the banking sector.
Leveraged sectors, Fertilizer and Cement remain key beneficiaries of the 50bps rate cut while high dividend yields with preferred picks (KAPCO, POL, PTC and FFC) would be attractive plays. Within the AKD Universe, greatest earnings impact from lower interest cost remains on the ENGRO, EFOODS, KEL and MLCF.