The State Bank of Pakistan is likely to adopt a tight monetary policy for next two months to contain rising inflationary pressure on the economy and stabilise the exchange rate. The Monetary Policy Statement (MPS) for two months is due in mid of November. Analysts said higher CPI, rupee depreciation and falling reserves will be the dominating factors in coming MPS and may force the SBP to increase interest rate by at least one percent.
The inflationary pressure on the economy is rapidly rising and CPI inflation surged to 9.1 percent in October 2013 Year on Year (YoY) basis because of 16 percent increase in electricity tariff and some uptick in food inflation. Analysts believed that inflation will further swell in future and will be in double digits in November, even if it posts zero percent growth, due to further impact of power tariff and low base in November 2012.
The rupee is also continually depreciating against the dollar and now is being traded at about 107.80 to a dollar. Pakistan is required to pay a cumulative $720 million to the International Monetary Fund (IMF) during this month, therefore Pak rupee will remain under stress and may further depreciate during next few weeks. In addition, the federal government borrowing from the central bank stood at Rs 600 billion during July 1 to October 25, 2013.
Ahead of these reasons, market is expecting that the SBP will adopt a tight monetary policy to curb the rising inflationary risk and stabilise the exchange rate. Analysts doubt about the increase taking place in the exact policy. However, all are confident that the SBP will increase interest rate.
"The SBP may raise the discount rate by 50 to 100 basis points (bps) in upcoming monetary policy as the inflation is rising, PKR is depreciating and reserves are depleting," said Sayem Ali, an economist at Standard Chartered. He said there is no hope of weakening inflation in future and it is likely to be over 10 percent at the end of November. He said the cut-off yield on long term bonds in secondary market is already on higher side, which clearly indicates some hike in discount rate.
"We are expecting a minimum increase of 50bps in key policy rate by the SBP aimed at containing inflation," said Khurram Shahzad an analyst at Arif Habib. He said market is 100 percent confident of a stiff monetary policy. Presently, discount rate stands at 9.5 percent and may be in double digit after the announcement of next MPS, he added.
"In the latest T-Bill auction there was very little appetite for long-term government paper as market was pricing interest rate hike," said another analyst at Aerari.com, an application that tracks currencies. The higher inflation and depreciation of the rupee will force the central bank to increase interest rate by at least one percent in its monetary policy, he added.
India has also raised its key Repo rates by 25bps twice in last 2 months, however, Pakistan's real interest rate is still lower than its regional counterparts, he said. Contrary to market expectations, the SBP in the previous monetary policy (announced in September 2013) increased the discount rate by 50bps to 9.5 percent. That was approximately 32 months since the policy rate hike was witnessed at 14 percent on January 30, 2011.
An unexpected and rapid increase in inflation, mainly due to the rising trend observed in international oil prices coupled with depreciation in Pak rupee against the greenback, was a major factor behind increase in rate. "We maintain expectation of further monetary tightening in November MPS with the higher probability of 50bps increase while low probability of raising 100bps in one go is also there," said Zeeshan Afzal, an analyst at Topline. Increase in discount rate will also enable the government to raise money from commercial banks and improve yields on local currency, he said and added that in last few months dollar investments have outperformed bond, stocks and real estate.
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