Pakistan Money Market Strategy
An Eye on Government Investment Bonds
Select Economic Indicators CPI Inflation Jun‐13 YoY 5.9% SPI Inflation Jun‐13 YoY 4.6% NFNE Inflation Jun‐13 YoY 7.8% Reserves on 5‐Jul‐13 USD10.5bn Remittances 11MFY13 USD12.7bn Trade Balance 11MFY13 USD(13.8)bn Current A/c deficit 11MFY13 6 Month KIBOR (Offer Rate) 17‐Jul‐13 9.07% 10 Year PIB 17‐Jul‐13 11.41% USD(2.0)bn Discount Rate ƒ
Persistent well‐behaved inflation and a further slowdown by the end of fiscal year (4QFY13 average 5.6% compared to 8.1% in preceding 9MFY13) led the State Bank of Pakistan to cut the policy rates by 50bps to 9% ƒ
With the cut being considered as the conclusion of monetary easing cycle on the back of upcoming uptick in inflation (factors mentioned below), the failure of materialization of a higher cut led the long term government bonds to retreat from their earlier gains ƒ
The debate centered not on ‘If’ but on ‘when’ and by ‘how much’, the money market has more or less accepted that FY14 will bring with it the monetary tightening cycle ƒ
A notable spread between DR and inflation which would take its due course to fill up despite seasonal impact, we believe the discount rates would remain in the same range till Dec13 ƒ
However 2HFY14 will start with a 50‐100bps increase in DR jacking up the discount rate to 9.5‐10% ƒ
In our assumption when interest rates are expected to remain same at least in next two monetary policies (Aug13 and Nov13), we believe the yields in the secondary markets will remain the same trajectory ƒ
However we believe, the capital gains should be settled on any upside while new positions should be maintained in short term instruments 9.0% Inflation Breakup (YoY) CPI
WPI
SPI
NFNE
14
12
10
8
Thursday July 18, 2013
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The Background 4
2
Jun‐13
Apr‐13
May‐13
Mar‐13
Jan‐13
Feb‐13
Dec‐12
Oct‐12
Nov‐12
Sep‐12
Jul‐12
Aug‐12
Jun‐12
0
Yield Curve Movement Since the initiation of monetary easing cycle, the yields have unsurprisingly come down. A cumulative cut of 450bps in last 2 years have lowered the yields of long term government bonds by 300‐460bps of tenure ranging from 2‐10years. The successive cuts in policy rates despite being in the IMF program were induced by the slowdown in inflation especially in FY13 (averaged 7.4% compared to 11% in FY12; real interest rates: 1.6%) primarily led by: 1) Change in index basing from FY01 to FY08 17‐Jul‐13
2) Well behaved food, fuel and house rent inflation and 17‐Jul‐12
3) Base affect especially after massive FY09 inflation levels (averaged at 20.8%) 14%
Though the cuts were intended to spur an uptick in private lending, law and order situation and power shortages kept the lending restricted to working capital requirements only. Having said that, the biggest borrower in the economy i.e. the Government of Pakistan (GoP) stood as the biggest beneficiary as their lending cost was reduced massively. Had the interest rates been at 14% (the case in FY11), the government’s borrowing in FY13 would have been higher by ~PKR372bn in FY13. 13%
12%
11%
10%
9%
30YR
15YR
9YR
7YR
5YR
3YR
1YR
6M
3M
1M
ON
8%
On the other hand, the initiation of the easing cycle benefitted commercial banks, funds and corporate entities by affording hefty capital gains on their long term government bonds. The current scenario Furqan Punjani furqan.punjani@bmacapital.com +92 111 262 111 Ext: 2064 Persistent well‐behaved inflation and a further slowdown by the end of fiscal year (4QFY13 average 5.6% compared to 8.1% in preceding 9MFY13) led the State Bank of BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262‐111 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.11
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Pakistan to cut the policy rates by 50bps to 9%. However, the money market participants were expecting the central bank to conclude the fiscal year with a deeper cut amid: 1) A steep spread of 160bps between policy rates and average FY13 CPI inflation, 2) A perceptional change in investment environment after change in the government 3) Unlocking of external inflows from middle east as PML‐N enjoys a better relationship with these countries and 4) PML‐N’s pro‐business policies may compel them to manage funds in such a manner that policy rates may remain lower Moreover, with the cut being considered as the conclusion of monetary easing cycle on the back of upcoming uptick in inflation (factors mentioned below), the failure of materialization led the long term government bonds to retreat from their earlier gains. To mention, the yields have come up by 40‐66bps (5‐10 yrs) since the monetary policy announcement. Recall that we forecasted the same retreat in the PIB yields and advising the participants to book some capital gains in our report titled ‘Secondary Market Ignoring Rare view’ dated June 04, 2013 on the back of: 1) Reversal in inflation cycle amid initiation of power tariff increase 2) Re‐entry into IMF program compelling the central bank to follow the changing inflationary trends and reduction in OMO 3) Mopping up of cash from secondary markets by the Government to fund energy sector injection (though this failed to materialize as government preferred to borrow from central bank). Yield Curve Comparison – Before and After DR Announcement 17‐Jul
4‐Jun
3‐Apr
13
12
11
30years
20years
15years
10years
9years
8years
7years
6years
7
5years
4years
8
3years
2years
9
1year
6 Months
10
3 Months
1 Month
Source: BMA Research What’s ahead? With the debate centered not on ‘If’ but on ‘when’ and by ‘how much’, the money market has more or less accepted that FY14 will bring with it the monetary tightening cycle. And to have a clear understanding of this, we would here highlight factors that will play the decisive role for the policy rates outlook. BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262‐111 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.22
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The factors that cry for further easing, though weakly, are: 1) Dried up private lending restricting the real economic growth 2) Certainty on non‐tax receipts including USD800mn from Estisalat, USD1.2bn from 3G Auctions and USD500mn from exchangeable bonds 3) Inflow of support funds from US (USD1.2bn for CSF) and ADB (USD600mn by Dec13 end) 4) Re‐entry into IMF to ease significant pressure off external account 5) Better tax collection after introduction of indirect tax measures And now our favorite ‘rear view’ (which actually has now become the front view) ie the factors advocating a DR hike: 1) Uptick in inflation during FY14E on the back of newly introduced revenue measures, power and gas tariff increase, PKR depreciation and low base affect. We believe the headline inflation to clock at 9.26% in FY14E (1HFY14 average 8.67% and 2HFY14 average 9.86%). This would slide the real interest to negative 26bps in the economy. 2) Re‐entry into IMF program (in 1QFY14) would compel the government to conclude the outstanding OMO amount (approx. PKR~250bn) 3) Re‐entry would also compel the central bank to devotedly eye rising inflation levels and decisive actions like rebuilding USD reserves & refraining from injecting USD into the secondary market, leading to a steeper PKR deprecation in the next few weeks of the program 4) Tax and power sector reforms would take their due implementation time before impacting the liquidity situation of the government and hence power subsidy may remain at ~PKR300bn for FY14E, compared to ~PKR450bn in FY13. To mention, the IMF requires the government to end subsidies in the next 3 years. Much of the DR movement is dependent upon two factors i.e. inflation and IMF EFF program (details to emerge later, IMF review report in next couple of weeks will also provide more understanding); these will be become visible post Ramadan. The uptick in inflation during FY14 (to be initiated by Ramadan factor followed by power tariff pass‐on) would make it difficult for the policy makers to continue with status quo for long, we beleive. Having said that, with a notable spread between DR and inflation which would take its due course to fill up, the discount rates should remain in the same range till Dec13. However 2HFY14 will start with a 50‐100bps increase jacking up the discount rate to 9.5‐10%. In our assumption when interest rates are expected to remain same at least in next two monetary policies (Aug13 and Nov13), we believe the yields in the secondary markets will remain in the same trajectory. However, we believe the capital gains should be settled on any upside while new positions should be maintained in short term instruments. BMA Capital Management Ltd. 801 Unitower, I.I.Chundrigar Road, Karachi, 74000, Pakistan For further queries, please contact: bmaresearch@bmacapital.com or call UAN: 111‐262‐111 This memorandum is produced by BMA Capital Management Limited and is only for the use of their clients. While the information contained herein is from sources believed reliable, we do not represent that it is accurate or complete and should not be relied upon as such. Opinions expressed may be revised at any time. This memorandum is for information only and is not an offer to buy or sell, or solicitation of any offer to buy or sell the securities mentioned.33
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