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Interest rate and forex outlook

In FY17, interest rates may rise on growing demand for private sector credit and also because banks may try to make up for high tax incidence through more interest income. This is a more likely scenario if the monetary policy is not eased any more, according to market observers.

Post-budget research notes of leading brokerage houses have pointed out that non-acceptance of banks’ demand to bring their tax rate at par with other industries and end super-tax could erode banks’ profits by 2.5pc-6.0pc.

A possible build-up in inflationary pressures building after an ambitious-but-deficit budget for FY2017 is one key factor that may bring an end to interest rate cuts by the State Bank of Pakistan, senior bankers say. According to them, the exchange rate, too, may come under pressure as nothing concrete is in sight for a strong growth in net forex earnings.

If private sector credit does not rise fast and if the government borrowing from banks does not go past the targeted level, the banks may find it difficult to increase interest rates particularly if the monetary policy is kept stable or, for argument’s sake, eased further.

“Political uncertainties may keep demand for long-term project financing low,” fears a head of a local commercial bank.

In eleven months of FY2016 (up to May 27) the private sector credit increased to Rs260bn against Rs182bn in the year-ago period, up 43pc. But whether it indicates a sustainable rise in credit demand or it is so because large businesses borrowed too heavily taking advantage of low interest rates is not clear.


The exchange rate may come under pressure as nothing concrete is in sight for a strong growth in net forex earnings


In FY2016, private sector credit intake remained concentrated in mining and quarrying, livestock and, in the industrial sector in food and beverages, textiles, electricity, gas and water supplies, construction, coke and petroleum, chemicals, rubber and plastics, fabricated metal products, electric machinery, communication apparatus, and automobiles etc.

Bankers say some of these sectors like mining and quarrying, livestock, textiles and construction can show strong credit demand also in FY2017 partly due to the budgetary measures to boost activities in these sectors and partly because high growth in their outputs (except in textiles) in FY2016 should keep their credit appetite to sustain output growth. Credit demand can also come from those sub-sectors of agriculture like crop farming, fisheries and horticulture that did not do well in FY2016 and are expected to perform better in FY2017 after budgetary subsidies and incentives.

“Besides, modest to moderate growth in credit, demand of petroleum sector is also expected from the oil marketing companies that invested heavily in capacity building in FY2016,” says head of credit division of a large local bank.

The government’s plan to borrow Rs453bn from banks will have an impact on interest rates movement in the context of overall economic environment. This higher borrowing — against the revised estimate of Rs199bn in FY2016, in itself does not mean banks will be employing funds at higher rates. Banks’ liquidity levels, private sector credit demand and liquidity levels (ahead of the auctions of government debt papers) will play a decisive role in interest rates movement.

Foreign exchange rates have remained stable for quite some time mainly due to strict market discipline enforced by the central bank and a crackdown against speculators. However, in third quarter of FY2016 a net balance of payment surplus of $313m and smaller balance of payment deficits in the first two quarters of the year (in comparison to a year-ago period) indicate that fundamentals are also improving, but largely due to heavy foreign borrowings.

In exchange rates movements in the next fiscal year two factors are worth watching, senior bankers say. One is whether the country is able to launch $750 eurobonds and whether its privatisation plan works out well. And, the second hinges on whether and how fast foreign direct investment pours in.

“If on these two counts we get what we want, the exchange rates may not remain under pressure particularly if we also manage to boost exports, keep growth rate of remittances from falling and the recent pick-up in FDI holds on,” says treasurer of a large local bank.

One aspect of exchange rate management is that foreign currency deposits, in the past attracted local savings for exchange rate benefits. But this trend seems to be weakening now. Such investors are focused on stocks, mutual funds and the real estate markets. This has affected growth in banks’ forex reserves build-up. Besides, since the SBP’s rules governing forex sales by exchange companies to banks have become more stringent and banks’ ability to remain too long or too short in dollar holding has also been checked through stricter monitoring, they have little room for manoeuvring.

“This simply means that forex rates will move more with fundamentals than anything else even on daily basis,” says treasurer of another bank. “Banks’ forex earnings will depend more on their skills in offering competitive rates and improved services to their clients.”

Upcoming China-Pakistan Economic Corridor projects involving FDI can also make a difference in how exchange rates move in the next fiscal year, bankers say. Usually the local banks provide loans for meeting the local currency financing needs. But in the CPEC projects like Gwadur development and cross country optical fibre installation, banks can get an opportunity to join hands with foreign banks in arranging the foreign currency component, according to head of a local bank. “That may lead to more hectic forex dealings within the banking industry putting some pressure on foreign exchange rates.”