Inflation and external stability: Policy rate hiked to 12.25pc at MPC emergency meeting

KARACHI: The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) in its emergency meeting, held on Thursday, decided to increase the key policy rate by 250 basis points (bps) to 12.25 percent to address the risks to inflation and external stability.

The committee believed that this strong and proactive policy response was necessitated due to deterioration in outlook for inflation and increase in risk to external stability since the last meeting.

The meeting of the MPC was scheduled to hold on April 19, 2022; however sensing the situation of the economy, the committee decided to meet before the schedule to take a decision on the policy rate. The committee meeting was chaired by Governor SBP Dr. Reza Baqir.

In the previous meeting held on March 8, the MPC maintained the policy rate unchanged at 9.75 percent; however, the committee mentioned that since the Russia-Ukraine situation remains fluid, it is prepared to meet earlier than the next scheduled MPC meeting in late April, if necessary, to take any needed timely and calibrated action to safeguard external and price stability.

Accordingly, the developments that were affecting the prospects for inflation, financial stability, and growth compelled the MPC to revise the policy rate upward side.

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The country’s economic indicators are deteriorating due to uncertainty and several developments on domestic and international front. The country’s foreign exchange reserves are on decline for the last few months and SBP’s reserves reached below $12 billion mark by end of March 2022. Exchange rate is also unstable and Pak rupee is continued to depreciate against the US dollar, which was traded at Rs 190 on Thursday in the open currency market. Cut-off yield of government securities is continued to surge since the last three auctions and one year yield of Market Treasury Bills rose to 13.3 percent in the auction held on Wednesday.

According to Monetary Policy Statement issued by the SBP, since the last MPC meeting, the outlook for inflation has deteriorated and risks to external stability have risen. Externally, futures markets suggest that global commodity prices, including oil, are likely to remain elevated for longer and the Federal Reserve is likely to increase interest rates more quickly than previously anticipated, likely leading to a sharper tightening of global financial conditions. On the domestic front, the inflation out-turns in March surprised on the upside, with core inflation in both urban and rural areas also rising significantly.

The developments on economic front necessitated a strong and proactive policy response. Accordingly, the MPC decided at its emergency meeting on Thursday, to raise the policy rate by 250 basis points to 12.25 percent. This increases forward-looking real interest rates (defined as the policy rate less expected inflation) to mildly positive territory. The MPC was of the view that this action would also help to safeguard external and price stability.

The policy rate has come into double digit after a gap of two years, previously, its 11 percent in April 2020.

The MPC also highlighted that Pakistan’s external financing needs in FY22 are fully met from identified sources. Looking ahead, the MPC noted that today’s decisive actions, together with a reduction in domestic political uncertainty and prudent fiscal policies should help ensure that Pakistan’s robust economic recovery from Covid-19 remains sustainable.

According to SBP, while timely demand-moderating measures and strong exports and remittances saw the February current account deficit shrink to $0.5 billion, its lowest level this fiscal year, heightened domestic political uncertainty contributed to a 5 percent depreciation in the rupee and a sharp rise in domestic secondary market yields as well as Pakistan’s Eurobond yields and CDS spreads since the last MPC meeting.

In addition, there has been a decline in the SBP’s foreign exchange reserves largely due to debt repayments and government payments pertaining to settlement of an arbitration award related to a mining project. Some of this decline in reserves is expected to be reversed as official creditors renew their loans.

As a result of these developments, average inflation forecasts have been revised upwards to slightly above 11 percent in FY22 before moderating in FY23. The current account deficit is still expected to be around 4 percent of GDP in FY22. While the non-oil current account balance has continued to improve, the overall current account remains dependent on global commodity prices.

The MPC also noted that SBP is in the process of taking further actions to reduce pressures on inflation and the current account, namely an increase in the interest rate on the export refinance scheme (EFS) and widening the set of import items subject to cash margin requirements. These items are mostly finished goods including luxury items and exclude raw materials. The announcement of these measures is expected soon and will complement the action taken by the MPC on interest rates.

It may be mentioned here that at its last meeting on 8th March 2022, the MPC noted in its statement the significant uncertainty around the outlook for international commodity prices and global financial conditions, which had been exacerbated by the Russia-Ukraine conflict. Given the unfolding situation, the MPC had highlighted that it “was prepared to meet earlier than the next scheduled MPC meeting in late April, if necessary, to take any needed timely and calibrated action to safeguard external and price stability.”

Copyright Business Recorder, 2022