Interest Rate Cut on the Cards Unless Something Shocking Happens on Domestic or Global Front

Wed Nov 15 2023
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Haris Zamir

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Interest rate has been much talked about word in the financial markets these days where mostly the observers are betting on the inflation numbers of November that it might see a correction while several opined that in the next outing of the State Bank of Pakistan the policy rate is likely to shed weight to give much need impetus to the economy which recently has been limping back to normalcy but requires a booster.

General phenomenon has been built up that the interest rate to see a fall of one or two percent in meeting scheduled to be held in December following the recent auction of the Pakistan Investment Bonds where three years long term bonds saw a fall of 1.80 percent, five years by 1 percent and 10 years by 15 basis points. Overall the three year bonds have dipped by almost four percent from the high of 21 percent. This cut of the mark up rate bodes well for the authorities as it has been the chief borrower to help meet fiscal gap and also in paying off domestic debt which has been increasing by leaps and bonds in the last decade or so. The latest numbers released by the State Bank of Pakistan showed that as of September 30, 2023 the domestic debt amounted to almost Rs 39,698 billion as compared with Rs 31,456 billion of September 2022, showing a whooping increase of 26.2 percent whereas the external debt rose by 25.5 percent to Rs 22,594 billion up from Rs 18,004 billion of the same period last year.

The domestic debt grew sharply because of the heavy borrowing made in the last over a decade. Another major factor behind the surge in borrowing has been rupee depreciation which added more pressure on the overall debt cycle. The domestic currency since August 2018 to date has been depreciated by 58 percent. In August 2018 it was quoted at Rs 124 to a dollar and now it has been hovering around Rs 284, the loss has been colossal and needs reforms and restructuring on a war footing basis.

The policy interest rate in April 22 was 12.25 percent and currently it has been 22 percent so in 18 months the interest rate has shown a rise of 9.75 percent which is still not in line with the inflation numbers which are around 31.4 percent but the recent rupee appreciation has halted the hike in interest rate. The rupee gained around 10 percent from its high of Rs 307 and settled around Rs 276 by mid of October, however, once again the rupee started facing a beating as no fresh big arrivals knocked the doors. After the Standby Agreement with the IMF in June where the country received $1.2 billion, $2 billion from Saudi Arabia and $1 billion UAE no other large inflows arrived which has been a major setback for the authorities as there was much talk that the rupee would witness a level of Rs 250. Again, the rupee has started to receive bashing from the greenbacks and since the middle of October it has been depreciated by almost 3.8 percent which again is creating a cause of concerns but not any among authorities had been paying heed to the increase in dollar value, which on average going up by 60 to 90 paisa a day.

The rise in interest rate created heaven for the banks as investment in treasury bills and Pakistan Investment Bonds have been a bonanza for the sector. In the nine months of 2023, the sector profitability posted 97 percent growth to Rs 400 billion amid higher interest income due to elevated interest rates. Moreover following significant rise in the profit, the banks disbursed huge amounts of dividend to its shareholders. The amount of dividend by the banks recorded a growth of 96 percent in the nine months of 2023, disbursing Rs 153 billion. Important to note that the amount paid to shareholders in nine months of 2023 has been higher than the dividend paid by the banking sector in the whole year of 2022.

The profits of the banks might suffer some hit in the second or third quarter of 2024 when the interest rates might see some major cuts.but as the government has been the major borrower and the reliance on the banks have been increased, the borrowing amount to increase in every quarter as the fiscal deficit would be higher than expected next year because the government spending would rise because of the election earmarked in February.

Stock Market Rally

Interest rates is expected to go down as the major consensus has been translated in the financial markets even the current rally at the stock market where it reached to all historic high of 53400 points. According to market observers some 2000 points gain recently in the KSE 100 index has been due to expectation that the benchmark rate to witness cut.

The stance cemented during the recent auction of the treasury bills where in the two of the outings, bids received from the banks were mostly centered around one year treasury bills.

The participation on average was around 80 to 85 percent glued to one year bills this clearly mandated that rate cut has been in offing.

The PIBs auction too show that cut in interest rate possible if some global shock in shape of crude oil price increase not set in. The three years PIBs cut off yield is down 4 percent from its peak and also down by almost same number from the policy rate of 22 percent.


SBP view

Recently the State Bank of Pakistan while maintaining the interest rate at 22 percent said that inflation will decline substantially from the second half of FY24, barring any major adverse developments.

The recent volatile and uptick trend in global oil prices, as well as the second-round effects of a substantial increase in gas tariffs, pose some upside risk to the inflation outlook.

Core inflation is also persisting at higher levels; remained around twenty-one percent during the last four months. Meanwhile, the Committee noted that fiscal policy is also contributing to the overall stabilization measures, which, coupled with better availability of food commodities, is likely to supplement the central bank’s efforts to bring down inflation.

Amayed Ashfaq Tola, President Tola Association said that State Bank of Pakistan (SBP) decided not to increase the interest rates was a good sign as higher rates have suffocated the economy. However, in my view, there existed grounds for decreasing the interest rates by 50 to 100 bps in the current MPC meeting.

The reason for the same is that since the last MPC meeting, the price of petrol  decreased by 7.20%, and diesel by 2.78%. and the price of Brent Crude by 6.63%, has given the SBP room to shed the interest rate by 0.5% – 1%. Even otherwise, the reduction of 1% of interest rate saves the Government around Rs 400 billion in debt servicing. The SBP must consider these ground realities and consider reducing the interest rates in the coming months.

The State Bank of Pakistan’s decision to hold interest rates, in my view, seems like a prudent move at this point, said Ali Nawaz, CEO Chase Securities. It’s like trying to balance on a seesaw—adjusting rates too hastily might tip the scales in an undesirable direction. Keeping rates unchanged could be a preemptive measure, a way of gauging the economic landscape before making significant adjustments.

“Perhaps, they forecasted that the current business atmosphere might not be very conducive to a rate cut as for the possibility of a change in stance for a relaxed monetary policy, 4QFY24 when inflation is expected to be around 16%”, he said. That could indeed be a turning point. High inflation rates might prompt a shift in strategy to stimulate economic activity. A loose monetary policy could potentially encourage spending and investment.

Now, onto the government’s role in curbing inflation, it’s like trying to put out a fire—you’ve got to address the root causes.

“Tightening fiscal policy, managing supply chains efficiently, and perhaps diversifying the economy could be crucial steps. Additionally, the government might need to tread carefully with interest rates”, Ali said. While lowering rates could stimulate spending, it might also fuel inflation further. It’s a delicate and beautiful dance, which is actually searching for the right balance.

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