State Bank of Pakistan (SBP) has announced 25 basis points increase in policy rate to 10.25 percent from today (Friday) for the next two months to compress demand to deal with the challenges of fiscal deficit as well as inflationary pressures.
Announcing the Monetary Policy here on Friday, Governor SBP Tariq Bajwa stated that monetary policy committee decided to increase policy rate by 25 basis points. According to him, despite the fact that impact of stabilisation measures implemented so far is gradually unfolding and confidence is improving, fiscal deficit is yet to show signs of consolidation despite slash in development spending and current account deficit remains high despite gradual improvement.
"Challenges to Pakistan's economy persist: despite narrowing, the current account deficit still remains high; fiscal deficit is elevated; and core inflation is persistently high. This situation calls for continued consolidation efforts," he added.
He said the monetary policy decisions with regard to discount rate are taken in the light of macroeconomic situation and there is a clear impact of policy measures in the form of 23 percent decrease in non-oil import on year-on-year basis.
He said that now the monetary policy committee has to see the macroeconomic fundamentals to decide whether the measures, which were helpful on external accounts, are to be continued or not. There is also a need to give a message to the market that these things are being done to move towards stability, he added.
Bajwa said the government borrowing from SBP entails inflationary concerns and even as stabilisation measures gradually work through the economy, underlying inflationary pressures persist.
When asked higher net borrowing of the government from SBP reflects that commercial banks are not ready to lend to the government and are dictating monetary policy, he stated that participation of banks in last auction was four to five times higher and this notion that banks are dictating the monetary policy is baseless.
He said that only permanent solution to current account deficit is market-based adjustment of rupee against dollar and currencies of other countries because maintaining overvalued exchange rate leads to de-industrialisation though dis-incentivising the industry, according to an in-house study.
He added that movement in exchange rate is determined in consultation with the government but was of the view that there must be long-term stability in exchange rate.
The Governor SBP stated that current account deficit is projected to be $13-14 billion for the current fiscal year and stated that financing requirements for the current fiscal year have been met. Bajwa said that some of the oil facility is also going to trigger in as modalities with regard to oil on deferred payment by Saudi Arabia have been finalised and final signing for the facility would take place on February 16, 2019 during the Saudi Crown Prince's visit to Pakistan.
He also stated that contractionary policy is being followed to reduced consumption. He said that foreign exchange reserves stand at $8.2 billion of the central bank after some repayments of commercial borrowing and defence payments. He also acknowledged that sometimes SBP intervenes in the market as well as mops up the liquidity.
He said that SBP policy target will make sure that banks' credit to the SMEs, agriculture sector and low-cost housing is increased because growth in these sectors provides direct support to the common man. He said the positive thing is that industry's off-take is increasing despite contractionary policy.
There is additional liquidity with the Islamic banks and the government's decision to involve them for issuance of Sukuk for power sector must be a welcome step for them.
He pointed out that China is a friendly country that has supported Pakistan through various instruments in time of difficulty whether through currency swap facility, credit financing or others.
Earlier, the SBP governor read out monetary policy statement which was subsequently distributed to media persons. It stated that economic data released after the last Monetary Policy Committee (MPC) meeting in November 2018 confirms that the stabilisation measures implemented during the last twelve months are taking hold. He added that key monthly indicators are showing visible signs of deceleration in domestic demand while current account deficit is narrowing, albeit gradually.
This, along with an increase in financial inflows, is contributing to reduced pressures on the country's external accounts. These developments are encouraging and have served to reduce some economic uncertainty.
Average headline CPI inflation stands at 6 percent for the first half of fiscal year 2019, which is considerably higher than the 3.8 percent recorded during the same period of last year. Meanwhile, headline year-on-year inflation has shown some moderation during the last two months, primarily due to a sharp fall in prices of perishable food items and a downward adjustment in prices of petroleum products.
Despite these positives, core inflation as measured by non-food non-energy components of the CPI basket has reached 8.4 percent in December 2018.
Going forward, the second round impacts of the exchange rate movements, upward adjustments in gas and electricity tariffs, and higher government borrowings from SBP are likely to be offset by the lagged impact of the increase in policy rates and the fall in international oil prices, on inflation. Accordingly, the projected range of inflation remains unchanged at 6.5 to 7.5 percent.
The pickup in inflation and the continuation of economic challenges are taking their toll on economic performance. Real economic activity has witnessed a marked slowdown during the first half of the year. Large-scale manufacturing, which has strong backward and forward linkages, saw a net contraction of 0.9 percent during the first five months of this fiscal year, mainly due to a moderation in domestic demand and some sector specific challenges.
Meanwhile, all major Kharif crops have recorded a decline in production from last year's levels. The initial assessment of the wheat crop is also not encouraging. Both the direct and the knock-on impacts of changes in commodity producing sectors on the services sector are likely to reduce real GDP growth for fiscal year 2019 to around 4 percent, well below both the annual target of 6.2 percent and the 5.8 percent growth realised in the previous year.
Credit to private sector saw a net expansion of Rs 570.4 billion during July-December 2019, which was almost double the level of expansion during the same period of last year. This growth is largely attributed to higher cost of raw materials (cotton, petroleum products, etc), continuation of capacity expansion in power and construction-allied industries (especially cement and steel), and favourable liquidity conditions due to retirement of government borrowing from commercial banks.
In absolute terms, net budgetary finance from SBP reached Rs 3,770.5 billion during July 1 to January 2019, which is 4.3 times the amount borrowed during the same period of last year. This financing will potentially have inflationary consequences in future. A major chunk of this borrowing was used to retire government debt from commercial banks (a net retirement of Rs 3,035.8 billion).
This huge shift in the government borrowing from commercial banks to SBP has incentivised private sector lending. The banks seem keen to redeploy their funds as there is hardly any increase in spreads charged by banks during the current cycle of monetary tightening and economic slowdown. Both the healthy credit offtake and higher government borrowing were the primary contributors to higher broad money (M2) growth of 2.2 percent during 1st Jul-18th Jan FY19 as compared to 1.1 percent during the same period last year.
The fiscal deficit for first half fiscal year 2019 is likely to be higher than the same period last year. This shows that despite a sharp cut in PSDP releases and rationalisation of tariffs and duties, fiscal consolidation remains a challenge.
The MPC reiterated its earlier view that fiscal policy will have to be proactive and play a supportive role to generate conditions for stability and sustainable growth.
On external front, the current account deficit recorded a year-on-year reduction of 4.4 percent during the first half of the year to US $8 billion. This improvement is largely driven by a sharp deceleration in import of goods and services.
The impact of stabilisation measures is amply visible from non-oil imports, which saw a contraction of 4.4 percent during the first half of fiscal year 2019 against an increase of 19.1 percent during the same period last year.
A marginal increase in exports and a healthy growth in remittances also helped contain the current account deficit. The financing of current account deficit, nevertheless, remained challenging as the private (Foreign Direct Investments and private loans) and official inflows were insufficient to completely finance the deficit.
Thus, a significant part of current account deficit was managed by using the country's own resources, which reduced the SBP's net liquid foreign exchange reserves to US $ 7.2 billion by end-December 2018.
However, the realisation of bilateral official flows in the last few days has helped increase SBP's net liquid foreign exchange reserves to US $ 8.2 billion and the country's foreign exchange reserves to US $ 14.8 billion as of 25th January 2019.
The MPC noted that the impact of stabilisation measures implemented so far is gradually unfolding and confidence is improving amidst reduced economic uncertainty, but (i) the fiscal deficit is yet to show signs of consolidation despite a reduction in PSDP spending; (ii) although a gradual improvement in current account deficit is visible, it remains high; (iii) a marked shift in the pattern of government borrowing from scheduled banks to SBP entails inflationary concerns; (iv) and even as stabilisation measures gradually work through the economy, underlying inflationary pressures persist.
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