Monetary policy: SBP keeps key interest rate unchanged at 15%

The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) has maintained the key interest rate at 15%, it was announced on Monday.

"With recent inflation developments in line with expectations, domestic demand beginning to moderate and the external position showing some improvement, the MPC felt that it was prudent to take a pause at this stage," the MPC was quoted as saying in the monetary policy statement.

"To cool the overheating economy and contain the current account deficit, the policy rate has been raised by a cumulative 800 basis points since last September, some temporary administrative steps have recently been taken to curtail imports, and strong fiscal consolidation is planned for FY23. These actions are expected to work their way through the system over the coming months.

In coming months, curbing food inflation through supply-side measures that boost output and resolve supply-chain bottlenecks should be a high priority: MPC on inflation outlook

"Looking ahead, the MPC intends to remain data-dependent, paying close attention to month-on-month inflation, inflation expectations, developments on the fiscal and external fronts, as well as global commodity prices and interest rate decisions by major central banks."

The MPC said it noted three key domestic developments including headline inflation that rose further to 24.9 percent in July, with core inflation also ticking up. "This was expected given the necessary reversal of the energy subsidy package – effects of which will continue to manifest in inflation out-turns throughout the rest of the fiscal year – as well as momentum in the prices of essential food items and exchange rate weakness last month.

"Second, the trade balance fell sharply in July and the Rupee has reversed course during August, appreciating by around 10 percent on improved fundamentals and sentiment.

"Third, the Board meeting on the on-going review under the IMF programme will take place on August 29th and is expected to release a further tranche of $1.2 billion, as well as catalysing financing from multilateral and bilateral lenders. In addition, Pakistan has also successfully secured an additional $4 billion from friendly countries over and above its external financing needs in FY23. As a result, foreign exchange reserves will be further augmented through the course of the year, helping to reduce external vulnerability."

The statement added that both global commodity prices and the US dollar have fallen in recent weeks, in response to signs of a sharper than anticipated slowdown in global growth and nascent market expectations that the US Federal Reserve tightening cycle may be less aggressive than previously anticipated.

"In contrast to the trend since last summer, more emerging market central banks have started to hold policy rates in their recent meetings. This suggests that globally, risks may be shifting slightly from inflation toward growth, although this remains highly uncertain at this stage.

"On balance, the MPC noted that some greater slowdown in global growth would not be as harmful for Pakistan as for most other emerging economies, given the relatively small share of exports and foreign private inflows in the economy. As a result, both inflation and the current account deficit should fall as global commodity prices ease, while growth would not be as badly affected."

This was the first MPC announcement after the government on Friday appointed Jameel Ahmad the new governor of the central bank for a period of five years.

Monetary and inflation outlook

The MPC said that private sector credit grew by around 21 percent (y/y) in FY22, somewhat faster than nominal GDP.

"The expansion was broad-based, with working capital loans accounting for the largest share owing to strong activity in sectors like textiles, food, construction, energy and wholesale and retail trade. In real terms, private sector credit growth was more subdued last year and actually declined by 3 percent in June, consistent with a moderating pace of economic growth. As desired, since the last MPC meeting, secondary market yields and cut-off rates in the government’s auctions are now well-aligned with the policy rate."

The statement said inflationary pressures intensified in July, with headline inflation rising by a further 3½ percentage points to 24.9 percent (y/y).

"The main contributors were food and energy inflation but core inflation also rose further, particularly in rural areas. In coming months, curbing food inflation through supply-side measures that boost output and resolve supply-chain bottlenecks should be a high priority.

"Encouragingly, there is evidence that inflation expectations of businesses have eased significantly. Looking ahead, headline inflation is projected to peak in the first quarter before declining gradually through the rest of the fiscal year. Thereafter, it is expected to decline sharply and fall to the 5-7 percent target range by the end of FY24, supported by the lagged effects of tight monetary and fiscal policies, the normalisation of global commodity prices, and beneficial base effects. This baseline outlook remains subject to uncertainty, with risks arising from the path of global commodity prices, the domestic fiscal policy stance, and the exchange rate. The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth."

Background

Most analysts expected no change in the monetary policy, which came at a time of rising inflation.

Monetary policy: a look at SBP's previous announcements

The Consumer Price Index (CPI)-based inflation hit 24.9% on a year-on-year (YoY) basis in July 2022, a 14-year high. The weekly review of the sensitive price index (SPI) on Friday also showed a record increase in inflation up to 42.31% on a year-on-year basis in August, data shared by the Pakistan Bureau of Statistics (PBS) showed.

Pakistan's current account deficit for June stood at $2.28 billion, up 59% compared with the figure in May when it stood at $1.43 billion.

Meanwhile, the government also lifted a ban on imports on the insistence of international organisations, but finance minister Miftah Ismail insisted that enhanced regulatory duties would control the inward flow of non-essential shipments.

The import ban had proved crucial in narrowing the rising trade deficit, which shrank by 18% YoY and 47% MoM during the month of July 22.

In the previous monetary policy meeting held on July 7 2022, the committee increased the benchmark policy rate by 125 basis points (bps) to 15%. In addition, it linked the interest rates of the Export Finance Scheme (EFS) and Long-Term Financing Facility (LTFF) with the policy rate and offered a discount of 500 bps relative to the policy rate to incentivise exports.