More monetary tightening seen ahead as PIBs yields steepen

KARACHI: The State Bank of Pakistan is expected to raise policy rate further this month due to rise in yields of long-term government bonds, a brokerage report said on Friday.

“Pakistan’s Investment Bonds cut-off yields in December were higher than secondary market rates by 7-44 basis points, which was a surprise for the market and a signal of further monetary tightening,” Topline Securities said in its report.

The central bank is due to announce monetary policy for the next two months later in January 2019.

The State Bank of Pakistan (SBP) hiked policy rate by 150 basis points (bps) to 10 percent in November last year.

A small amount of Rs22.5 billion was accepted in the last PIBs auction held on December 26, 2018 with a cut-off yield for 3, 5, and 10 years at 12.2 percent, 12.7 percent, and 13.1 percent, respectively.

Moreover, these cut-offs are up 472bps, 345bps and 442bps higher over the last auction for 3, 5, and 10 year PIBs, respectively, the report noted.

The next PIB auction on January 23, 2018 will have strong implications for the local equity and bond markets. The government in the last PIB auction gave the cut-off for PIBs after rejecting bids for two months.

“We believe that upcoming PIB auction will likely see strong participation specifically from non-banking financial companies like mutual funds (including pension funds) and insurance companies,” the report said.

It added that some banks may also now participate, given these high interest rates, while most of the banks would participate after Pakistan’s entering into an IMF (International Monetary Fund) program, as per channel checks.

Topline said steepening of yield curve was an indication that market was expecting further monetary tightening. “A significant amount pickup will result in ratification of government’s debt profile and movement of debt from SBP to banks,” the brokerage said.

The government has increasingly resorted to the central bank since the end of last IMF program (in October 2016) and borrowing from it now stands at Rs7 trillion, up Rs5.5 trillion, since FY2016, the report added.

The report sees listed banks will accumulate PIBs in the coming auctions and PIB-to-deposit ratio is expected to increase to 30 percent in December 2019 from 15 percent in September 2018, translating into Rs2.2 trillion of additional PIBs.

Approximately Rs720 billion worth of PIBs are also maturing in 2019, which will take the total PIB participation of listed banks to Rs2.9 trillion.

“It should be noted that borrowing from central bank and printing of currency is inflationary. Borrowing from banks (through PIBs) will result in lengthening of government’s debt profile. A shorter debt maturity profile has higher re-pricing risk,” it said.

The government issued a huge Rs2.5 trillion worth of PIBs in 2014. During this time, the banking sector took significant participation in the auctions where the listed banks cumulatively added Rs1.8 trillion PIBs to their investment portfolios taking their PIB-to-deposit share to 28 percent by December 2014 from 9 percent in December 2013.

However, Fitch Solutions, a macro research arm of the global credit ratings agency, in its latest report, expects the SBP to keep interest rates unchanged for the remaining fiscal year as it evaluates the effect of massive monetary tightening in 2018 and gives its support to foster economic growth.

Fitch also expects the economy to grow at a slower pace of 4.4 percent in FY19 and fiscal and external accounts to remain vulnerable.

Consumer Price Index (CPI) inflation for December 2018 stood at 6.17 percent year-on-year, compared with 6.5 percent in previous month.

“CPI inflation has now clocked in at 6.0 percent during 1HFY19 and is anticipated to average 7.5 percent in FY2019.

The rise in 2HFY19 is because of expected further hikes in energy prices and likely increase in taxation measures to bridge the yawning fiscal gap,” Topline Securities said in another report published earlier this month.