200bps cut hailed as step in right direction

KARACHI: The State Bank of Pakistan’s (SBP) 200 basis points (bps) rate cut is largely being seen as a step in the right direction by experts, but they say that more needs to be done to revive the economy.

In his conversation with The News, Chief Executive Officer of the Pakistan Business Council (PBC) Ehsan Malik said the 200 basis-point (bps) cut is “consistent with our expectations”.

The SBP slashed its benchmark interest rate by 200bps, bringing it down to 13 per cent on Monday. This marks the fifth rate cut this year as policymakers strive to breathe new life into a sluggish economy, buoyed by easing inflationary pressures, the central bank said in a statement.

Malik added that this will keep inflationary and current account pressures in check and support gradual and sustainable growth.Per macroeconomist Ammar Habib Khan, the central bank maintained “a cautious stance”, adding that the market had already anticipated the cut to be around 200bps, given yields in the secondary market.

“A cautious stance remains the best way forward to consolidate position in the external front, and maintain a stable parity for the rupee,” Ammar explained.Karim Punjani, former equities and treasury fund manager, however, added that while this move aligns with the expectations of most equity market participants, it “fell short of the treasury market’s anticipation of a larger cut, as reflected in three-month to one-year bond yields. Core inflation remains sticky, and a new base is forming, prompting the central bank to opt for a measured approach to rate adjustments.”

He projected that future rate reductions are likely to be smaller as the high-base effect diminishes and headline and core inflation normalise towards historical averages.In recent months, the government took several measures to contain ever-rising inflation. Dr Khaqan Najeeb, former adviser to the Ministry of Finance, said, “Headline inflation has considerably eased to 4.9 per cent in November 2024 year-on-year (YoY) from 29.2 per cent in November 2023 due to containment in demand, improvement in the supply of food items, lower oil prices and a high base effect.”

These measures, according to him, have created room for policy easing with the policy rate now down nine percentage points since easing began a few months ago.Echoing Ammar’s sentiment, Khaqan added that the 200bps easing in the current MPC meeting is “prudent” as core inflation at 9.7 per cent is sticky, “and the fiscal side is fragile as tax collection is short of target in 5MFY25 and may require new measures which pose an inflationary risk.”

On inflationary pressures, Malik expressed: “Another consideration is the forward outlook on inflation, which will likely limit further expectations of a cut to 100bps in 2025 and settling at 12 per cent.”

While the experts have welcomed the rate cut, they maintain that the challenges remain. Former finance minister Miftah Ismail said that while the SBP rate “will relieve the burden on industry a bit, we still have the highest power and gas prices in our region and some of the highest income and sales tax rates in the world.”

On that basis, he said, “I do not see us getting any substantial foreign and domestic investments, which can reduce unemployment or poverty.”Khaqan added: “Credit to the private sector has increased, due to easing in financial conditions and the effort of the banks to meet required ADR levels. These factors combined with improvement in business confidence are likely to support economic activity in the country.”

The stock market on Monday surged by over 1,860 points to settle at 116,169.41, largely driven by rate cut expectations. Karim explained: “in the equity market, the average PER [price-to-earnings ratio] remains low, and mutual funds are driving a shift from fixed income to equities, with significant inflows ($91 million month-to-date, averaging $6-7 million daily). This trend supports a focus on undervalued stocks”, potentially making the market attractive to investors seeking growth opportunities.

Another analyst who covers GCC markets said, on the condition of anonymity, “the rate cut is yet another sign of inflation coming down. This will further boost investor confidence and allow transfer of capital from debt market to equity market. Moreover, companies that are highly leverage will see their finance cost going down sequentially and will be able to generate higher return on equity.

But is a decline in interest rate a bad sign for bank stocks? According to Karim, banks have two issues now: “earnings will either decline or remain flat as interest rates are going down and then there is the additional ADR tax on earnings, hence in terms of dividends to investor, they might be same, but earnings growth will be limited.”

“Other cyclical stock with high leverage will witness earnings growth like steel, cement textiles and volumes of automobile will increase.”Senior banker Adnan Alam Khan, who works as head of Internal Control over Financial Reporting (ICFR), said that a low rate is likely to result in reduced returns on fixed deposits, savings accounts and other interest-based investment products.

“To counter lower savings returns, customers may explore alternative investment opportunities such as stocks, mutual funds or real estate, potentially increasing market activity.”On the consumption level, he anticipated the rate cut to encourage spending as reduced borrowing costs for credit cards and personal loans may enhance consumers’ ability to spend, particularly on big-ticket items like cars.

For customers with variable interest rate loans, such as personal loans, car financing and mortgages, the rate cut will lower monthly repayments, easing their financial burden. Lower interest rates make home financing more affordable, which could attract more customers to the real estate market. This may lead to a surge in demand for housing, he added.