CUT AUGURS WELL FOR EQUITY MARKET
Aug 8 - 14, 2011
Finally, State Bank of Pakistan realizes the problem faced by the investors on account of high interest rate and decided to slash benchmark interest rates to 13.5 per cent from 14 per cent.
The industrialists and general investors have welcomed the decision but demanded more reduction in interest rate so that the economy could revitalize.
One of the main economic challenges that Pakistan has faced in the recent decades is controlling inflation in order to mitigate the effects of increasing in prices of goods and services. The interest rate hike was made in a bid to curtail inflation but desirable results could not be achieved.
Pakistan has one of the world's highest benchmark interest rates, in an economy pummeled by inflation, terrorism and falling foreign investment. The IMF, which bailed out Pakistan in 2008 to avert a balance of payments crisis, has repeatedly urged caution in cutting interest rates, listing persistent inflation as one of the worries for the economy.
Experts told PAGE that the analysis of last few years clearly shows that the SBP's tight monetary policy has failed to bring down inflation caused by increased fuel, food and power prices, and exchange rate depreciation.
The business community has been demanding lower interest rates to promote private sector investment and to stimulate the economy. High interest rate is resulting in less economic activity.
Businesspersons maintain that increases in electricity, gas and the petroleum product prices have already hurt business and industry and the present interest rate is unacceptable for entrepreneurs as it is like depriving them of affordable financing. This in turn is reducing business income and also restricting the government's ability to meet its tax collection target.
Experts are of the view that reduction in 50bps is good for equity markets in general and many companies in particular. We may see many commercial banks thronging into equities after some easement in the three-day discount window of SBP. We may see banks suffering from book losses on bonds and commercial papers but they can make money on equities.
They said cut in the cost of borrowing by the central bank is a good omen for the leveraged sectors, as their earnings might improve if the current downward trend in Karachi Inter Bank Offer Rate (KIBOR) persisted. The latest easing of the policy rate, the experts believe, would also benefit the banking sector in the long term however it would erode their 7.65 per cent spreads in the shorter term.
They said apart from textile and cement, the likely major gainers due to high leverage are companies like Engro and Pakistan State Oil (PSO) who would also benefit due to cut in interest rate. "Pakistan's largest textile manufacturer annualized earnings are likely to increase by one per cent while in cement sector DG Khan Cement and Lucky earnings are expected to increase by three per cent and one per cent, respectively. This is based on the recent decline of 44bps in lending rate," the experts said.
Similarly, the earnings of heavy weight PSO in the oil-marketing sector would improve by Rs1.3 per share. "The company is facing liquidity constraints due to ongoing circular debt as its net receivables would be more than Rs60 billion,î experts added.
A number of leveraged companies are expected to take a breather on financial charges that are often linked with Pakistani bonds or 6M KIBOR, while many other companies including Fatima, Engro Corp., Agritech among fertilizer and DG Khan Cement, Lucky Cement, Fauji Cement among cement companies will benefit from the reduction in financial charges.
Some positive impact is also expected for companies who are presently suffering from heavy circular debt such as PSO, Nishat Power, Nishat Chunian Power etc. Among banks, MCB, UBL, ABL, HBL, and NBP are to benefit from cut in interest rate. The downward revision of interest rate would augur well in the long-term for the banking sector, which would improve its advances.
Credit squeeze is hitting and hindering the private business and restraining the economic output. If the situation continues unabated, this trend of the banks growing exposure to government's financing needs is likely to restrain the performance of the private sector.
The business and industry has been demanding lowering the interest rate apart from bringing down the cost of doing business in the country. Rising cost of production is making Pakistani exports non-competitive and hurting domestic demand for a wide range of products and services. From 1992 until 2010, Pakistan's average interest rate was 12.78 percent reaching an historical high of 20 percent in October of 1996 and a record low of 7.50 percent in November of 2002.