Businessmen and industrialists have built high hopes for the cut in discount rates from 50 basis points to 100 basis points in the upcoming monetary policy statement which posed pressure on the central bank.
The major indicators including headline inflation level and consolidation of external account made a favorable room for the central bank to cut the discount rate significantly though banking industry may bear the burn of its impact as major earning drives from interest income may drag down their profitability.
Analysts said that the probability is high that SBP will follow a gradual policy of reducing benchmark interest rate because it is difficult to forecast the global price of oil after a sudden fall. Improved external sector outlook could be another key trigger for a likely rate cut as its scenario has also been very stable lately as total foreign exchange reserves of the country currently stand at $15.2 billion, whereas the reserves held by SBP are over $ 10.3 billion (equivalent to 3 months import cover).
As a result, rupee has been pretty stable recently. In 2014, it has appreciated by 5% against US dollar due to increasing foreign inflows. Money market is anticipating a 100bps cut in upcoming MPS as yields on government securities have declined significantly by 124-280bps in fourth quarter of 2014. Currently, 2-year PIB is trading at 9.0% which is down by 280bps, whereas yields on 6mo T-bills have declined by 124bps to 8.7% in 4Q2014.
Real interest rates have also increased significantly due to widening gap between interest rates and inflation. In December 2014, real interest surged to 5.2% while first half of FY15 real interest rate averaged at of 3.7%. Since this rate is significantly higher than the historical average of 2 percent, downward adjustment in interest rate makes sense. In terms of macroeconomic recovery and the agreed targets with International Monetary Fund (IMF), Government is largely on track. However, lower revenues on oil products and increased spending on law & order situation could lead to higher fiscal deficit. Government had set a fiscal deficit target of 4.9% for FY15 which is likely to be missed due to above mentioned reasons. An expected slippage on fiscal deficit target could also be one reason why SBP would opt for a cautious approach. Hence, it is expected that SBP will slash the policy rate by 50bps in upcoming MPS and go for a further cut of 50bps later on.