Morning Call about – Monetary Easing: Valuations turn more attractive with correction! – Arif Habib Limited

Karachi, June 24, 2013 (PPI-OT): Policy rate cut on inflation decline, fiscal and external risks remain The State Bank of Pakistan (SBP) while placing more emphasis on inflation decline and slender private sector credit than risks to the balance of payments position cut the policy rate albeit a token 50bps to 9%.

According to Arif Habib Limited as mentioned in pre- MPS write-up, the core inflation (trimmed mean at 6.1% vis-à-vis CPI at 5.1% for May’13) amid moderate aggregate demand was referred to as the key indication of the declining inflationary trends and, one of the main reasons for easing.

While the SBP sliced policy rate, it kept its stick pointed towards the chronicle energy crises and security issues terming them as main reasons for below potential GDP growth (3.6% for FY13E against 4.3% forecast) and investments (private fixed capital formation growth at -1.6%, 5 th consecutive year of decline), respectively.

Tax reforms, targeted subsidies with fiscal restructuring key to revival
The SBP continued to underline significantly low foreign financial inflows and high fiscal borrowings from the banking system as mounting economic challenges, while implying monetary policy’s relevance the SBP put fiscal side restructuring as the utmost need to undo economic dents that have been created amid insignificant tax reforms and untargeted subsidies.

The main reason underlying has been the financing of fiscal deficit (8.8% for FY13E, 6.3% for FY14F), being completely funded by domestic sources (PKR 1,230bn, including PKR 413bn from SBP). However, the SBP put considerable weight on the positive change in the political setup and its potential impacts on investor-consumer sentiment that could improve much-needed investment flows while the central bank termed higher- than-needed real interest rates as unsupportive to private investments.

Inflation to re-emerge in 2HFY13, 8% target for FY14 naïvely forecast
Going forward, since inflationary pressures are expected to increase given 1) 1% increase in GST and other tax measures, 2) Ramadan effect (from mid-July) when food prices jack up, and 3) rise in electricity tariffs, SBP’s concern with respect to gov’t inflation target at 8% for FY14 being optimistic is quite valid especially if planned foreign flows are met with unintended delays.

Market valuations turn massively attractive amid rate cut and corrections
Of course, decline in interest rates (KIBOR) will lead to valuations upgrade for stocks where to Arif Habib Limited estimates a 50bps decline in rates to have a valuation impact of 1.8% for market.

Sector-wise impact would be more intense, especially for leveraged ones like Textile, Cements and few Fertilizers while banks would be negatively impacted due to further squeeze on spreads (since deposit rates glued to 6% and lending rates down).

Overall valuations impact (including EPS and Target Price impacts) are provided in the table alongside. Current correction in perspective (including today’s over 600pts due to negative news flows on political front) provides an added opportunity to take fresh positions in valued stocks.