At an emergency meeting on Thursday, the Monetary Policy Committee of the State Bank of Pakistan (SBP) decided to raise the policy rate by 250 basis points to 12.25%.

In a surprise statement, the SBP said that since the last MPC meeting, the outlook for inflation has deteriorated and risks to external stability have risen.

"The MPC decided at its emergency meeting to raise the policy rate by 250 basis points to 12.25 percent," it said on Thursday. "This increases forward-looking real interest rates (defined as the policy rate less expected inflation) to mildly positive territory."

The SBP's announcement comes on the day when the rupee hit yet another record low against the US dollar, closing over the 188 level in the inter-bank market. Thursday's depreciation brought cumulative fall to nearly 6% since March alone.

In its statement, the MPC said it was of the view that the interest-rate hike would help to safeguard external and price stability.

"The MPC also noted that SBP is in the process of taking further actions to reduce pressures on inflation and the current account, namely an increase in the interest rate on the export refinance scheme (EFS) and widening the set of import items subject to cash margin requirements.

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"These items are mostly finished goods including luxury items and exclude raw materials. The announcement of these measures is expected soon and will complement the action taken by the MPC on interest rates today."

It highlighted that Pakistan’s external financing needs in FY22 are fully met from identified sources.

"Looking ahead, the MPC noted that today’s decisive actions, together with a reduction in domestic political uncertainty and prudent fiscal policies, should help ensure that Pakistan’s robust economic recovery from Covid-19 remains sustainable."

Reasons for emergency meeting

Citing reasons for the emergency meeting, the SBP said externally, futures markets suggest that global commodity prices, including oil, are likely to remain elevated for longer and the Federal Reserve is likely to increase interest rates more quickly than previously anticipated, likely leading to a sharper tightening of global financial conditions.

"On the domestic front, the inflation out-turn in March surprised on the upside, with core inflation in both urban and rural areas also rising significantly. Heightened domestic political uncertainty contributed to a 5 percent depreciation in the rupee and a sharp rise in domestic secondary market yields as well as Pakistan’s Eurobond yields and CDS spreads since the last MPC meeting.

"In addition, there has been a decline in the SBP’s foreign exchange reserves largely due to debt repayments and government payments pertaining to settlement of an arbitration award related to a mining project. Some of this decline in reserves is expected to be reversed as official creditors renew their loans."

As a result of these developments, average inflation forecasts have been revised upwards to slightly above 11 percent in FY22 before moderating in FY23. The current account deficit is still expected to be around 4 percent of GDP in FY22. While the non-oil current account balance has continued to improve, the overall current account remains dependent on global commodity prices.

The MPC noted that the developments necessitated a strong and proactive policy response.

Reaction

In a note, Ismail Iqbal Securities (IIS) said the SBP has not included any forward guidance in this policy statement.

"However, this action is likely to be decisive," said IIS Research. "The real rates on forward looking basis are positive for first time in 2 years. The SBP is not planning to take any more actions."

It added that inflation has surprised on the higher side but expected to remain sticky at current levels in near term.

Previous MPC meetings

September 2021: First hike in over 2 years: SBP raises key interest rate by 25 basis points

November 2021: Monetary policy: SBP raises key interest rate by 150 basis points, takes it to 8.75%

December 2021: 3rd successive hike: SBP increases key interest rate by 100 basis points, takes it to 9.75%

January 2022: Monetary policy: SBP keeps policy rate unchanged at 9.75%

March 2022: SBP keeps interest rate unchanged at 9.75%