ISLAMABAD: The government has committed to the International Monetary Fund (IMF) that the policy rate was raised to 22 percent on June 26, 2023, and it stands ready to consider further action in the next Monetary Policy Committee (MPC) meeting in July and the coming months, until inflation expectations are on a clear downward path.
This has been revealed in the IMF report, “Country Report, Request For A Stand-By Arrangement”.
“To anchor inflation expectations and support the exchange rate, we raised the policy rate to 22 percent on June 26, 2023; and stand ready to consider further action in the next MPC in July and the coming months, until inflation and inflation expectations are on a clear downward path, with the exact pace of future adjustments dependent on inflation data, exchange rate developments, the strength of the external position, and the fiscal-monetary policy mix,” the authorities informed the Fund.
SBP raises key interest rate by 100bps, takes it to 17% — a 25-year high
It further stated, “to this end, we will aim to ensure that the real policy rate returns to positive territory on a forward-looking basis to signal our commitment to bring inflation within the target band within fiscal year 2026. In addition to the policy rate increase, we have reduced the interest rate gap between the policy rate and the interest rate on the two major refinancing schemes (EFS and LTFF) to three percentage points. To strengthen monetary policy transmission, these rates will continue to be linked to the policy rate and will adjust automatically.”
The Fund stated that the recent policy rate hike is welcome, but the tightening cycle should continue if needed to reduce inflation and facilitate external rebalancing. In the short term, the forward-looking real policy rate should return to positive territory to re-anchor expectations and achieve the SBP’s inflation objective over the medium term. Implementing the plan to phase out the refinancing schemes will strengthen monetary policy traction and will bring transparency to these schemes. Importantly, the independence of the SBP should be strengthened and protected.
The Fund stated that a tighter monetary policy stance is critical to reduce inflation, re-anchor expectations, and support external sector rebalancing through the exchange rate. Although the latest policy rate move from the SBP is a welcome step, the authorities have generally been sanguine about inflationary pressures quickly receding and returning to their 5–7 percent inflation target range byend-FY25. Staff emphasized that the SBP will need to continue its tightening cycle to re-anchor expectations given that inflationary pressures are expected to persist over the coming year, including because the impact of exchange rate corrections will continue to reverberate through the economy.
The SBP agreed to maintain a tight monetary policy stance—higher rates and prudent use of liquidity injections — as needed, given incoming data, to achieve real positive interest rates, on a forward-looking basis, and place inflation and inflation expectations on a clear downward path. At the same time, improving the monetary transmission and the monetary operation framework will be important. The SBP is also committed to not introduce new refinancing schemes and to keep the outstanding credit of the refinancing facilities below their current limits.
The Fund stated that inflation has proven to be quite stubborn in Pakistan. To anchor expectations and combat inflationary pressures, the monetary policy was tightened considerably as the policy rate has been raised by 800 bps since August 2022. It currently stands at 22 percent, compared with seven percent two years ago. The authorities agree to maintain the tight monetary policy stance as long as necessary as they intend to return to 5-7 percent inflation target band by end June 2024. SBP further removed all FX restrictions with the purpose of ensuring full market determination of the exchange rate and has also capped the rates on its refinancing scheme facilities. Since movements in the exchange rate earlier this year, the market liquidity and functioning have improved considerably. The authorities have requested temporary approval of exchange restrictions considering the limitation on advance payments for imports against LCs. Both exchange restriction and MCP are nondiscriminatory and are being maintained for BOP reasons, which we intend to remove by the end of the programme.
The report noted that in the last six months, inflation has continued to rise, in part due to rising food prices and the past through from the depreciation, but also as the abovementioned shortages placed upward pressure on prices. Price dynamics became increasingly broad-based with core inflation reaching 22.8 percent (YoY) and headline inflation reaching 38 percent in May 2023, a record high, hurting especially the poor. Despite the mounting pressures, actions by the State Bank of Pakistan (SBP) lacked clarity, as it kept its policy rate unchanged in Monetary Policy Committee meetings in August, October, and early June, expecting that the price rises had peaked and would subside, but hiked rates in November, March, April, and late June. The last hike brought policy rates to 22 percent (cumulatively, an 825 bps (basis points) increase since the beginning of FY23).
Copyright Business Recorder, 2023
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