The State Bank of Pakistan (SBP) is due to announce its monetary policy statement on March 8, 2022. Recent surveys indicate that market participants are split between a status quo and a hike which would bring the policy rate into double digits. This indecision is reflected in secondary market yields that have started to inch up over the past couple of weeks. It would be instructive to assess developments that may influence the decision making of the monetary policy committee (MPC).
Inflation has been trending higher with the latest CPI reading coming in at 12.24%. Interestingly the Sensitive Price Indicator (SPI) which measures prices for items of daily use is at 18.70% while the Wholesale Price Index (WPI) is at 23.6%. The WPI is often considered a leading indicator for CPI as prices are eventually passed on from manufacturers to consumers.
This of course does not bode well for the future inflation trajectory especially considering the run up in commodities which has seen oil, gas, cooking oil, wheat etc. hit multiyear highs. The silver lining is core inflation where readings are still under 10%, while CPI is projected to undergo a sharp decline in 4QCY22 as the high base effect kicks in.
The SBP has also indicated that it will look through temporary supply side pressures and dropped guidance on achieving positive real interest rates in the near term. Interestingly the central bank has run real negative rates for the last 2 years. This is unprecedented in Pakistan’s monetary history and can be attributed to the fallout from the Covid epidemic. Nevertheless inflation is likely to average 12%+ for CY22 which may bring MPC hawks into play.
The current account deficit (CAD) has grabbed all the headlines and January witnessed the highest ever monthly recording of USD 2.6 billion. This brings the fiscal year to date deficit to USD 11.6 billion.
Surprisingly, the SBP has for the most part managed to keep its FX reserves intact. They were USD 17.3 billion in June 2021 and ended January at USD 16.6 billion, down by just 4%. This is in direct contrast to earlier years where high external deficits have led to steep drawdown’s in SBP reserves (FY08: -35.7%, FY18: -39.5%, FY19: -25.4%).
SBP-held foreign exchange reserves fall $344 mn, stand at $16.46bn
This means Pakistan has been successful in bridging the deficit through debt financing from multiple sources. Whether this trend can continue is the big question as the IMF will ask some tough questions in the current review.
Moreover with Pakistan’s eurobond yields spiking to 13%+, the planned issuance of the ESG bond in March may have to be put off. Another delay in the program would put pressure on USD reserves and currency which after a sharp depreciation during 2HCY21 has been relatively stable in the new year. The central bank will also have to revise its CAD projections for FY22 as 70% of the import bill is directly impacted by commodity prices. These may continue to remain elevated unless there is a rapid de-escalation of geo-political tensions in Europe.
Unfortunately fiscal discipline has started to slip. The recently announced subsidy package where the prices for petrol, diesel, electricity have been slashed may provide temporary relief to the beleaguered middle income groups, but is ultimately unsustainable for a country that is caught in a structural fiscal and external deficit.
The mini budget and pass on of commodity prices had provided comfort to the SBP last time around, as it meant monetary and fiscal policy were coordinating to moderate demand. Now the central bank has been left to shoulder the burden of macroeconomic stabilization alone. This is a throwback to previous cycles where interest rates would bear the brunt of slowing down the economy while fiscal profligacy continued unabated. This meant that interest rates rose higher and faster than otherwise required (FY08/FY09: +4.50%, FY18/19: +6.00%). At least this time we have a relatively flexible currency which can pick up some of the slack.
All in all, developments since the last MPS have increased the probability of a rate hike. The SBP will have to balance the need to be proactive and re-establishing the credibility which it lost in the flip flop of 2021. This point needs to be stressed as credible policy making is a cornerstone of an effective monetary stance. With such an aggressive tone taken on the interest rate pause in January, a reversal would have material implications for future signalling.
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