Its common to see ‘news’ drive ‘markets’. In some cases, there is news that may not catch much attention, but becomes something that throws the markets in turmoil. The news of Shamshad Akhtar being appointed as caretaker Finance Minister was not something many dwelled upon. But shrewd traders in the banking industry anticipated the repercussions. That day Rupee weakened from 291 to 295 whereas 10 year bonds yields rose by 30 bps, anticipating rising interest rates. Rumours about this caretaker government coming in for an indefinite period added fuel to fire.
Known for her tough love
While Ms Akhtar is well respected in the industry, she is known for being orthodox & conservative. In her last stint as SBP Governor she consistently gave more weight to financial discipline over growth, often times failing to maintain a balance. With this precedent in view, traders are anticipating a realignment of interest rates to inflation as well, and further depreciation of the currency. After all, why would someone hold on to Rupee if it has a negative carry of 7-9%, unless you believe in Erdonomics which has the highest negative real interest rate in the world.
Its fiscal!
While above measures may be termed as tough, Pakistan can greatly benefit from financial discipline. After all, the entire crises is preponed because we have not been able to manage our fiscal side. In our view, she may be the best choice to undertake non-populist & tough measures to address the fiscal crises, including abolishing subsidies & exemptions, rationalising tax collection, privatising SOEs and introducing efficient pass through mechanisms.
To her credit, she has stuck around in Pakistan’s financial scene even when everything around her was up in flames.
CAD, Reserves & REER
Current Account unfortunately broke the 4 month surplus spree by posting a deficit of $809mn. The main factor was release of stuck up payments, especially in the aviation sector.
Total country reserves inched up higher by about $40mn, where as REER depreciated from 87.7 to 91.6
Analysis of past caretaker governments
A quick analysis of the last 5 interim governments shows that the local currency has depreciated every time, with an average of about 6%. The currency also depreciated, every time, in the first 3 months that the new elected government came in, averaging about 3%.
Whereas interest rates increased by an average of 80 bps in interim government phase, but stayed largely stable in the first 3 months of elected government.
Currency outlook
Market is bracing for Rupee to cross past the historic level of 300/$. This appears to be the market consensus, especially if we look at the factors mentioned above. However, in our opinion, there is a material likeliness of an adhoc hike in interest rates which may relieve some pressure off the Rupee. Essentially, we expect Rupee to trade the coming week under the 300 level. Our view also factors in increase in swaps depicting healthy liquidity levels and micro management of imports and based on the premise that a weak Rupee will further exacerbate the inflation problem.
China’s Woes dominate Markets’ mood
Bankruptcy of China’s Evergrande is akin to the US’ Freddie & Fannie moment, producing a tense atmosphere which has engulfed global markets as it combines with soaring US bond yields and poor liquidity conditions. This has caused the US dollar to bounce back with the USD Index climbing to multi month highs or around 103. Sterling has also gained on a hot inflation report.
