SBP raises key interest rate by 300bps, takes it to 20%

The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) on Thursday raised the key interest rate by 300 basis points, taking it to 20% — the highest level since October 1996 – as it bids to control runaway inflation.

“At its meeting held on 2nd March 2023, the MPC decided to increase the policy rate by 300 basis points to 20%,” it said in a statement, in which it also announced moving the next MPC meeting to April 4 from April 27.

“During the last meeting in January, the Committee had highlighted near-term risks to the inflation outlook from external and fiscal adjustments. Most of these risks have materialised and are partially reflected in the inflation outturns for February. The national CPI inflation has surged to 31.5 percent y/y, while core inflation rose to 17.1 percent in urban and 21.5 percent in rural basket in February 2023.”

The MPC reiterated its earlier view that the short-term costs of bringing down inflation are lower than the long-term costs of allowing it to become entrenched: Monetary Policy Committee statement

The MPC statement said that in today’s meeting, the committee noted that the recent fiscal adjustments and exchange rate depreciation have led to a significant deterioration in the near term inflation outlook and a further upward drift in inflation expectations, as reflected in the latest wave of surveys.

“The Committee expects inflation to rise further in the next few months as the impact of these adjustments unfolds before it begins to fall, albeit at a gradual pace.

“The average inflation this year is now expected in the range of 27 - 29 percent against the November 2022 projection of 21 – 23 percent. In this context, the MPC emphasised that anchoring inflation expectations is critical and warrants a strong policy response.”

On the external side, the MPC noted that despite a substantial reduction in the current account deficit (CAD), vulnerabilities continue to persist.

“In January 2023, the CAD fell to $242 million, the lowest level since March 2021. Cumulatively, the CAD – at $3.8 billion in Jul-Jan FY23 – is down 67 percent compared to the same period last year. Notwithstanding this improvement, scheduled debt repayments and a decline in financial inflows amid rising global interest rates and domestic uncertainties, continue to exert pressure on FX reserves and the exchange rate.”

The MPC noted that FX reserves remain low and concerted efforts are needed to improve the external position. In this regard, conclusion of the ongoing 9th review under the IMF’s EFF will help address near-term external sector challenges. Furthermore, the MPC stressed on the urgent need for energy conservation measures to alleviate pressure on the external account and meet the import requirements of other sectors.

“Recent fiscal measures – including an increase in GST and excise duties, reduction in subsidies, adjustments in energy prices, and the austerity drive – are expected to help contain the otherwise widening fiscal and primary deficits. As highlighted in earlier statements, the envisaged fiscal consolidation is critical for economic stability and will complement the ongoing monetary tightening in bringing down inflation over the medium-term.”

The Committee emphasised that any significant fiscal slippages will undermine monetary policy effectiveness in the context of achieving the price stability objective.

The MPC also assessed the impact of further monetary tightening on financial stability and the near-term growth outlook.

“The Committee views that the risks to financial stability remain contained, given that financial institutions are broadly well capitalised. On growth, however, there exists a trade-off. The MPC, nonetheless, reiterated its earlier view that the short-term costs of bringing down inflation are lower than the long-term costs of allowing it to become entrenched.

“Barring unexpected future shocks, the MPC noted that today’s decision has pushed the real interest rate in positive territory on a forward-looking basis. This will help anchor inflation expectations and steer inflation to the medium-term target of 5-7 percent by end FY25.”

Background

The MPC meeting was originally scheduled for March 16, 2023, but the SBP decided to prepone it to deal with emerging risks to the economy including a record CPI figure, which clocked in at 31.5% in February.

MPC meeting on March 2: market expects 200bps hike in key policy rate

An emergency meeting outside of the SBP-issued advance calendar happened last year in April in which the MPC raised the policy rate by 250 basis points.

Since the MPC meeting held in January 2023, in which the SBP raised the key interest rate by 100 basis points, a number of key economic developments on the domestic front have taken place.

The Consumer Price Index (CPI)-based inflation clocked in at 31.5% in February on a year-on-year basis.

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On a month-on-month basis, it increased to 4.3%, data released by Pakistan Bureau of Statistics (PBS) said.

Meanwhile, the Sensitive Price Indicator-based inflation for the week ended February 23, 2023 was recorded at 241.29 points against 234.77 points registered in the previous week. However, a major increase was observed in the prices of food items.

Pakistan’s current account deficit declined by more than 67% during the first seven months of this fiscal year (FY23) mainly due to a lower import bill.

The current account recorded a deficit of $3.799 billion during July-January of FY23 compared to $11.558 billion in the same period of last fiscal year (FY22), depicting a decline of $7.75 billion.

Economists say the federal government’s measures to curtail rising imports have reduced some pressure on the country’s current account.

However, despite the measures, foreign exchange reserves held by the SBP are languishing at $3.258 billion as of February 17, 2023, latest data showed. An inflow of $700 million is expected from the China Development Bank, but has yet to be reflected in the official reserves’ position.

Despite a slight gain, foreign exchange reserves are not enough to cover even one month of imports and disbursement of funds from the International Monetary Fund (IMF) remains delayed despite several measures taken by the government including an increase in the gas and electricity tariff and implementation of additional tax measures of Rs170 billion through a mini-budget.