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Oil Prices Could Plunge – SBP Should Cut Rate by 200 bp

March 8, 2015


It was quiet and eventful week, as ECB maintained its extremely loose monetary policy stance that was followed by Draghi’s press conference, which unlike past carried less weight and was ineffective. ECB boss was clearly directionless, as market paid no heed to his higher future growth forecast. Market is more concerned about the disagreement between ECB and Greece, which remains a threatening issue.

Furthermore, Friday’s US jobs data confirmed that the economy is on the right track, rising hopes that FED may consider rate hike sooner than earlier thought, which could happen this year sometime around June to December, FED did not hike US interest rate since 3rd quarter of 2006.

However, next major event will be FED’s 2-days policy meeting, starting on March 17. Market will be watching the language for next interest rate direction, which should be supportive. Therefore, US Dollar is likely to maintain its string tone. Minor corrective rally is possible, but any correction will encourage buying of Greenback.

OIL = $ 59.90 – WTI $ 50.15

OPEC has been dominating oil market for few decades, nevertheless increased North American shale production in recent years have changed the Oil Mathematical calculation, as growth in shale production in USA is reducing American reliance on imported crude oil, which has seen drop in US oil import by more than 50 pct.

Though demand and supply factor is the contributing element, but it is still too difficult to make future assessment of oil market based on any calculations due to mix of oil production.

However, three factors that we have to keep in mind is the impact of economic sanctions on Russia, which is a mystery, as the Russian oil export in February surged by 4.8 pct to 10.654 million barrels a day.

Likely increase of oil production by Iraq in coming months and possibility of easing of international sanctions on Iran, if ongoing nuclear talk succeeds, as Iran is presently allowed to ship only half of its total exports. However, despite US oil import demand that has fallen by nearly 50 pct of its requirement, USA may not be able to dictate terms in the oil market.

While, OPEC is likely to continue to dominate global oil market. It is because USA is still a big importer of oil to meet its domestic need, whereas, majority of the OPEC members are net exporter and are too dependent on oil money.

But, oil market is totally a different ball game. The current bounce back of oil price recovery is not due to surge in global economic growth. Minus USA, rest of the world economy still struggling to recover.

Whereas, US shale oil production is playing major role to help in reviving its economy by meeting 50 pct of its Domestic demand. It is the closure of expensive shale oil units in USA that gave glimmer of hope to the oil producers.

Further, Oil prices got boost due to tension in the Middle East region. But now, Iran is on a compromising path. While the biggest worrying factor is the massive oversupply of oil. So by combining two-factors imagine oil glut. The real worry is excessive supply of oil that clearly lacks storage facilities.

The problem is that you just cannot plug oozing oil. There is hardly any space left in the storage terminals. Supertankers and empty pipelines could be are other minor option, but then what next ? Storage is costly too, as estimated cost for 2-barrels of oil per month is nearly One US Dollar.

Hence, simple economic logic is that when there is a demand, price will rise. This means instead of storing oil, panic selling could take place in next 1-3 months time. Therefore, we may have seen the top or it remains around US 65 per barrel. In all probability, unless there is another global unrest in the oil belt region, it matter of few weeks, before oil prices plunges by another 15-25 US Dollar.

Pakistan Economy/inflation =             

This year since January, 18-Central Banks have slashed its Interest Rates to kick start its respective economy. Reserve Bank of India that has the Hawkish Central Bank boss Raghuram Rajan surprised the market by cutting rates for second time this year to attain its high growth rate target.

Here, despite sharp fall in inflation, Pakistan’s Central Bank has been slow to act and have been too defensive to bring changes in its policy stance. Higher Discount Rate Policy is one of the major causes hindering growth.

For any country, National Security tops the priority list that covers all dimensions of politics, economics, technology, social issues, environmental and defense. Apart from defense and military security, economic security should be the preferred dimension of Pakistan’s National Security. We talk a lot about military spending.

But if we look at things from our resource capacity perspective, there is hardly any policy/planing that supports economic security of the country. We proudly discuss various types of expensive loans/borrowings, but do not and cannot boast of industrial or manufacturing sector growth.

Why? Because so far we have done nothing remarkable that we can speak with excessive pride. The delay in SBP monetary stimulus, which is an autonomous body could be due to excessive interference by Pakistan’s Foreign Minister.

However, though belated, but recently there have been some useful monetary moves, which may not enough as more adjustment is required for economic stimulation purpose. Realistically speaking there is a huge gap between inflation and SBP discount rate. This is because despite cut in petrol and electricity rates, transportation cost and food prices did not decline at same proportion.

Coming back to inflation, February CPI was 3.24 pct. Average inflation from July to February was 5.45 pct. As I am bearish for oil prices in coming months, I do not see higher adjustment of oil prices by the government until Fiscal Year end i.e June 2015.

Instead at current pace, CPI is likely to drop further and could end up between 4.50 pct – 4.75 pct, and expecting further dip to around 4.25 pct to 4.50 pct in 3rd and 4th Quarter of 2015. Some of the recent SBP move is in right direction and is encouraging.

Last month in his meeting/address to Bank heads SBP Governor urged to rationalize “Average Spreads” by end of June 2015 or SBP could take regulatory measures. There was another interesting move, as SBP announced big chopping by fixing financing for energy plants rate to 7.5 pct that will be loaded by another 2.5 pct (cost) by the lending institutions.Hope this offer is not misused.

In another positive and big move that went unnoticed and could not get press coverage is slash of PIB Coupon Rate of 3-5-10 and 20 years. E.g, Coupon Rate of 10-year PIB was revised down to 9.75 pct from 12 pct. This move will save government over Rs 50 billion annually.

But current Coupon Rate is still too attractive for banks and hence, they will refrain from increasing the size of its Balance sheet, which means no major corporate lending.

Due to wide gap between Inflation Rate and Discount Rate, State Bank of Pakistan should do justice with the Standard Operating Procedure (SOP) and abide by the global norms/practice with its policy rate. Therefore, to encourage Private Sector bank lending, Coupon Rate should be further reduced by another 200 basis point in next 3-6 months.

To stimulate economy and for Private sector lending, Pakistan’ Central Bank should make two more downward adjustments by slashing Discount Rate by 100-150 basis points and cut rate by another 100 basis point sometime in the new fiscal year based on inflation data. Or else current exercise of rate cut will be futile effort that may not serve the purpose and hence, could lead to further economic unrest/imbalance.

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