LAHORE - The State Bank of Pakistan (SBP) is scheduled to release the first Monetary Policy Statement (MPS) for FY13 on August 10. It is expected SBP to cut the discount rate by 50-100bps from current level of 12%.

The fundamental reason to our stance is the continuous decline in CPI over the past few months, clocking in at 9.6% YoY in Jul-12. Additionally, real interest rate remains positive to the tune of 2.4%. However, the major economic bottlenecks like twin deficits, huge government borrowing etc will be taken into consideration before deciding to cut the interest rate.

Due to higher interest rate policy, private sector growth is choked as a large part of the credit has been diverted to the government sector. This has adversely affected the overall economy, thus calling in for a serious thought on easing cost of borrowing. Presently, the real interest rate rests in the green zone at +2.4%, signaling a possible discount rate cut in upcoming MPS.

This will result in availability of credit to private institutions on lower rates.

The banks have been witnessed to show more inclination towards the long term bills i.e. six monthly and yearly market treasury bills, as evident in last two to three auctions( latest on July 25, 2012). The cut off yields have considerably gone down, pointing at the drifting market sentiments regarding interest rates. Thus, one of the reasons for the shift of investments in short term to the longer term maturities could be the expectations for cut in policy rate developing among the investor community which will be announced on August 10.

All’s not as simple as it seems to be for the central bank to slash discount rate. Aggravating demand side constraints like the unabated public sector borrowing and other fiscal pressures will remain a matter of concern for the SBP.

The government in FY12, has mainly resorted to the scheduled banks for budgetary support (PKR 2,093bn stock) rather than seeking SBP’s assistance (PKR 1,706bn stock). This has intensified the pressure on the central bank to regulate the money supply in the overall economy.

Although the impediments in overall economy suggest an unchanged rate, the latest inflation figures going down to single digit hint that the upcoming monetary policy could offer a 50-100bps cut in the policy rate.