KARACHI: The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) on Tuesday further tightened the monetary policy stance and raised the policy rate by 100 basis points (bps) to an all-time high level of 21 percent to curtail the rising inflation.
The MPC believed that monetary tightening will help to achieve the medium-term inflation target; however, the domestic political uncertainty and global financial conditions may pose risks to this assessment.
Cumulatively, the committee has increased the key policy rate by 725 bps during this fiscal year. The policy rate was stood at 13.75 percent in June 2022; however, the rising inflation has compelled the committee to tight the monetary policy to address the inflation risk to economy. In the previous meeting held on March 2, policy rate was increased by 300 bps to 20 percent.
SBP seen raising key rate to record 22pc as inflation bites
The meeting of MPC was held on Tuesday at SBP head office and chaired by the Governor SBP Jameel Ahmed. The MPC believed that policy rate increase decision is as an important step towards anchoring inflation expectations around the medium-term target, which is critical for achieving the objective of price stability.
During the meeting, the MPC noted that inflation in March 2023 rose further to 35.4 percent, and is expected to remain high in the near term.
However, there are early indications of inflation expectations plateauing, albeit at an elevated level. The Committee also observed that Pakistan’s financial sector remains broadly resilient, while economic activity continues to moderate.
The Committee also reemphasized that the early conclusion of the 9th review under the IMF program is critical to rebuild the FX reserve buffers as despite the lower current account deficit, higher loan repayments relative to disbursements are keeping the foreign exchange reserves under pressure.
Since the last meeting, the Committee noted three important developments having implications for the macroeconomic outlook. First, the current account deficit has narrowed considerably, more than previously anticipated, mainly on the back of sizable import containment.
Nonetheless, the overall balance of payments position continues to remain under stress, with foreign exchange reserves still at low levels.
Second, significant progress has been made towards completion of the 9th review under the IMF’s EFF program. Third, recent strains in the global banking system have led to further tightening of global liquidity and financial conditions. These have added to the difficulties of the emerging market economies like Pakistan to access international capital markets.
According to SBP, in this context, the MPC considers the current monetary policy stance appropriate, and stresses that today’s decision, along with previous accumulated monetary tightening, will help achieve the medium-term inflation target over the next 8 quarters.
However, the Committee noted that uncertainties attached with the global financial conditions as well as the domestic political situation, pose risks to this assessment.
As the MPC had anticipated, national CPI inflation further rose to 35.4 percent in March 2023, resulting in average inflation of 27.3 percent during Jul-Mar FY23.
The MPC noted that the surge in inflation was broad-based, though a large part of it was contributed by food and energy components due to the pass-through of increases in taxes and duties, unwinding of untargeted energy subsidies and the recent exchange rate depreciation.
Importantly, core inflation has risen to 18.6 percent in urban and 23.1 percent in rural baskets, indicating the second-round impacts of the above-mentioned adjustments.
The Committee also viewed the increase in core inflation as partly driven by the elevated inflation expectations, as indicated by recent sentiment surveys. To anchor these expectations, the MPC views its current monetary policy stance as appropriate to keep the real interest rate in positive territory on a forward-looking basis.
According to Monetary Policy Statement issued after the meeting, MPC noted that the incoming data on economic activity continues to reflect a broad-based slowdown.
The contraction in large-scale manufacturing (LSM) accelerated in January to 7.9 percent y/y. Cumulatively, LSM output is down by 4.4 percent during Jul-Jan FY23 when compared with corresponding period of last year.
In agriculture, the information on cotton arrivals remains as per expectation; however, wheat production target is likely to be missed. These developments, combined with the lagged impact of the recent monetary tightening and new fiscal consolidation measures implemented since beginning of March, suggest growth in FY23 will be significantly lower than the post-floods assessment of November 2022.
On external sector side, in February 2023, the current account saw a deficit of only $74 million and the cumulative deficit now stood at $3.9 billion in Jul-Feb FY23, 68 percent lower from the same period last year.
CA declined due to contraction in imports, which continues to outweigh the combined decline in remittances and exports. Importantly, workers’ remittances have slightly recovered on MoM basis in February and the momentum is expected to continue in coming months.
The Committee views that the fiscal outcomes during Jul-Jan FY23 have been encouraging in the context of achieving macroeconomic stability.
Copyright Business Recorder, 2023
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