Projected 7% Reduction in Policy Rate for CY24

Anticipations are high that Pakistan's central bank will implement a substantial seven-percentage-point cut in its benchmark policy rate – the cost of lending to commercial banks – in the upcoming calendar year, bringing it down to 15%. This move is expected to breathe new life into the provision of affordable financing, particularly benefiting industries heavily reliant on bank borrowing, such as textile, cement, steel, and agriculture.

The report, titled "Commercial Banks Overcoming Headwinds – Resilient Near-Term Profitability Expected" by economist Sana Tawfik from Arif Habib Limited, foresees commercial banks achieving a 12% growth in net profits in 2024. This stands in contrast to the general assumption of reduced earnings following the rate cut and the imposition of a 40% tax on windfall income from speculative rupee-dollar exchange transactions.

Tawfik noted that not only would traditional sectors like textile, cement, steel, and agriculture benefit from the policy rate cut, but also energy sectors, including oil and gas exploration firms and power companies.

The research house predicts a robust economic growth of 3.3% in the current fiscal year, surpassing the government and central bank's forecast in the range of 2-3%. This higher growth is attributed to the easing of monetary policy, which is expected to benefit the industrial, agricultural, and services sectors.

Tawfik suggests that the central bank may initiate a symbolic reduction of 50-100 basis points in the policy rate in its January 2024 monetary policy announcement. The broader rate cut initiative is expected to commence alongside a significant easing of inflation from March 2024 onward, although inflation is expected to remain elevated at around 28% in November due to a substantial hike in gas prices in November 2023.

The primary beneficiary of the rate cut is anticipated to be the government, as it will reduce interest payments on its growing debt, creating fiscal space for necessary development expenditures and economic stimulus.

The report further anticipates that the current account deficit will be kept under control at around $4 billion. Additionally, rupee stability, expected recoveries in the currency in the initial months of FY24, and no major depreciation as seen in previous years will further support economic growth. The upcoming general elections in February 2024 and the expected signing of a larger IMF loan program are seen as catalysts for attracting foreign currency inflows.

With the rate cut and other supportive measures, Tawfik predicts a substantial increase in Pakistan's economic growth to 4.3% in the next fiscal year, 2024-25.

In light of these developments, Tawfik suggests that the Pakistan Stock Exchange (PSX) is poised for significant growth, as major financial institutions, including mutual funds and insurance companies, are redirecting investments from fixed-income instruments to the stock market.

The report concludes by stating that despite potential headwinds from a reversal in the policy rate cycle, a cumulative 7% reduction in the policy rate in CY24 is expected to maintain near-term profitability for the banking sector, supported by factors such as the lagged effect of asset re-pricing, potential balance sheet expansion, and opportunities for capital gains on the fixed Pakistan Investment Bonds (PIBs) portfolio. The impact of the 40% tax on banks' windfall income from rupee-dollar exchange business is expected to affect net profits only once in the fourth quarter of CY23. Earnings are anticipated to remain robust in the next few quarters, with a projected 12% growth in CY24, despite potential credit cost increases due to the implementation of IFRS-9 effective from January 2024.

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