Encouraged by 'positive developments', SBP keeps interest rate unchanged at 7%

The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) has kept the key interest rate unchanged at 7% for the next two months.

"At its meeting on 27th July 2021, the MPC decided to maintain the policy rate at 7 percent," read the monetary policy statement on Tuesday. "Since its last meeting in May, the MPC was encouraged by the continued domestic recovery and improved inflation outlook following the recent decline in food prices and core inflation.

"In addition, consumer and business confidence have risen to multi-year highs and inflation expectations have fallen. As a result of these positive developments, growth is projected to rise from 3.9 percent in FY21 to 4-5 percent this year, and average inflation to moderate to 7-9 percent this year from its recent higher out-turns."

CAD: Time to manage imports

The statement added that Pakistan's imports are expected to grow on the back of the domestic recovery and rebound in global commodity prices, albeit more moderately than in FY21. Pakistan's imports clocked in at $53.8 billion during the previous fiscal year, contributing significantly to the trade deficit even as exports registered a historic high.

The MPC noted that the market-based flexible exchange rate system, resilience in remittances, an improving outlook for exports, and appropriate macroeconomic policy settings should help contain the current account deficit in a sustainable range of 2-3 percent of GDP in FY22.

"Notwithstanding this moderate current account deficit, the country’s foreign exchange reserves position is expected to continue to improve this year due to adequate availability of external financing. Against this backdrop, the MPC felt that the uncertainty created by the on-going fourth Covid wave in Pakistan and the global spread of new variants warrants a continued emphasis on supporting the recovery through accommodative monetary policy."

This one will be a sustained economic recovery, says SBP

Addressing the key question of sustained improvement, the MPC said that there were good reasons to expect that the current economic recovery would be accompanied by external stability.

"Given expected resilience in remittances and an improving outlook for exports, the current account deficit is expected to converge toward a sustainable range of 2 - 3 percent of GDP in FY22. This is much lower than in FY17 and FY18, when the current account deficit increased to around 4 and 6 percent of GDP, respectively, and FX reserves fell by $2 billion and $6.4 billion, respectively.

"Moreover, imports this year are expected to be more skewed toward machinery rather than consumption compared to FY17, and machinery imports are projected to be better distributed across sectors than in FY18, when power and telecommunications dominated.

"With the contained current account deficit and healthy commercial, official, portfolio and FDI inflows, Pakistan’s external financing needs of around $20 billion are expected to be more than fully met in FY22. As a result, foreign exchange reserves are projected to rise further."

'Results being witnessed'

Meanwhile, SBP Governor Dr Reza Baqir, flanked by Deputy Governor Dr Sima Kamil, Deputy Governor Dr Murtaza Syed and Ali Choudhary at the virtual press conference, said that keeping the policy rate at 7% for over a year has reaped results.

Talking about the government’s flagship project of housing and construction for low-income persons, Baqir said that the central bank is confident that the program will grow further. To date, banks have received loan applications amounting to Rs124 billion of which Rs45 billion have been approved, while disbursements to the tune of Rs 5.8 billion have been made, informed Baqir.

Baqir added that the central bank would soon launch a scheme for SMEs, under banks will provide which collateral-free loans, and the government would give guarantee on the principal amount.

On a query regarding its decision to allow banks to deduct charges for inter-bank funds transfer, Baqir said the decision was made to balance the playing field that would allow industry players to invest further in the digitisation infrastructure.

Majority expect status quo in upcoming monetary policy announcement

Earlier, a majority of financial market participants had expected the MPC to keep the key interest rate unchanged.

“Keeping in view SBP’s medium-term inflation projection and its stance to support domestic demand, we expect the policy rate to remain unchanged at 7% in July’s MPS,” said Arif Habib Limited (AHL) in a research note circulated earlier.

As per a survey poll conducted by AHL, 78% of the total respondents are of the view that the SBP will keep the policy rate unchanged in July’s MPS.

Similar results were shared by Topline Securities in its market poll. “We are expecting no change in the policy rate in the Jul-2021 monetary policy statement (MPS), while we expect an increase during 2H2021 (second half of 2021),” said Topline in its research note.

In May, the central bank had also kept the key interest rate at 7% for the next two months as it expected monetary policy to remain accommodating in the near term and any adjustments in the policy rate will be measured and gradual to achieve mildly positive real interest rates over time.

The policy rate was last changed in June 2020, when MPC decided to cut it by 100 basis points to 7 percent and since then it has remained unchanged. Back then, MPC noted that the priority of monetary policy has shifted toward supporting growth and employment amid a slowdown in the domestic economy.

Meanwhile, on the external front, Pakistan closed FY21 with historic high levels of exports (goods) and remittances i.e. $25.3bn and $29.4bn, respectively. However, the current account posted a deficit of $1.9 billion in FY21, with a huge $1.6 billion deficit recorded alone in the month of June 2021. However, on a YoY basis, current account deficit has come down by 58% during FY21, the lowest deficit after 10 years. A surplus of $214 million was posted FY11.