KARACHI: The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) on Thursday increased the key policy rate by 300 basis points (bps) to 20 percent with a view to taming inflation.
The committee has also stressed on the urgent need for energy conservation measures to reduce pressure on the external account and meet the import requirements.
Barring unexpected future shocks, the MPC noted that decision of monetary tightening has pushed the real interest rate in positive territory on a forward-looking basis. The MPC believed that this decision will help to anchor inflation expectations and steer inflation to theme medium-term target of 5-7 percent by end-FY25.
MPC meeting preponed, will now be held on March 2, says SBP
The emergent meeting of the MPC was held on Thursday and chaired by the Governor SBP Jameel Ahmed to review the economic indicator and take a decision on the key policy rate. As per schedule the MPC was due on March 16, however due to uncertain development on economic front, an emergent meeting was called on March 2 to address the risks to the economy due to higher inflation outlook.
During the meeting, the MPC noted that the recent fiscal adjustments and exchange rate depreciation have led to a significant deterioration in the near term inflation outlook and a further upward drift in inflation expectations, as reflected in the latest wave of surveys.
In this context, the MPC emphasized that anchoring inflation expectations is critical and warrants a strong policy response. Accordingly, the committee decided to increase the policy rate by 300 basis points to 20 percent, which is the highest level of last 26 years. Previously, policy rate was 20 percent in Oct 1996. Overall, the policy rate has rose by 625 bps during this fiscal year as it was 13.75 in June 2022.
The Committee expects inflation to rise further in the next few months as the impact of these adjustments unfolds before it begins to fall, albeit at a gradual pace. The Committee has also revised the inflation outlook and now the average inflation this year is now expected in the range of 27-29 percent against the November 2022 projection of 21-23 percent.
According to monetary policy statement issued after the meeting, during the last meeting in January, the Committee had highlighted near-term risks to the inflation outlook from external and fiscal adjustments. Most of these risks have materialized and are partially reflected in the inflation outturns for February. The national CPI inflation has surged to 31.5 percent y/y, while core inflation rose to 17.1 percent in urban and 21.5 percent in rural basket in February 2023.
On the external side, the MPC noted that despite a substantial reduction in the current account deficit (CAD), vulnerabilities continue to persist. In January 2023, the CAD fell to $242 million, the lowest level since March 2021. Cumulatively, the CAD stood at $3.8 billion in Jul-Jan FY23, down 67 percent compared to the same period last year.
Notwithstanding this improvement, scheduled debt repayments and a decline in financial inflows amid rising global interest rates and domestic uncertainties, continue to exert pressure on FX reserves and the exchange rate.
The MPC noted that FX reserves remain low and concerted efforts are needed to improve the external position. In this regard, conclusion of the ongoing 9th review under the IMF’s Extended Fund Facility (EFF) will help address near-term external sector challenges.
Furthermore, the MPC stressed on the urgent need for energy conservation measures to alleviate pressure on the external account and meet the import requirements of other sectors.
Recent fiscal measures including an increase in GST and excise duties, reduction in subsidies, adjustments in energy prices, and the austerity drive are expected to help contain the otherwise widening fiscal and primary deficits.
In addition, the envisaged fiscal consolidation is critical for economic stability and will complement the ongoing monetary tightening in bringing down inflation over the medium-term. The Committee emphasized that any significant fiscal slippages will undermine monetary policy effectiveness in the context of achieving the price stability objective.
The MPC also assessed the impact of further monetary tightening on financial stability and the near-term growth outlook. The Committee views that the risks to financial stability remain contained, given that financial institutions are broadly well capitalized.
On growth, however, there exists a trade-off. The MPC, nonetheless, reiterated its earlier view that the short-term costs of bringing down inflation are lower than the long-term costs of allowing it to become entrenched.
The committee also decided to hold its next meeting on April 04, 2023 which was earlier scheduled for April 27, 2023.
Reuters adds: The key rate of the State Bank of Pakistan (SBP) now stands at 20%, its highest level since October 1996, with consumer price inflation now at its highest level for almost 50 years. Investors polled by Reuters had expected a rate hike of 200 bps.
“We expect a further 200bps of hikes over the coming months,” Capital Economics said in a note.
The SBP had brought forward its Monetary Policy Committee (MPC) meeting from an original date of March 16, with local media saying the rate hike was a key requirement to get the IMF funding released.
CPI RISES TO 31.5%
Suleman Maniya, head of advisory at Vector Securities, said that while the CPI could potentially increase more with fiscal actions related to subsidy removals and exchange rate weakness, the government needed to urgently focus on improving the supply side, especially of food and agricultural items. For its part, the government is trying to cut expenditure and increase revenue through taxes, and has allowed the rupee to depreciate.
Pakistan’s consumer price index (CPI) jumped 31.5% in February year-on-year as food, beverage and transportation prices surged more than 45%.
As per the ninth review of a previous deal with the IMF, the global lender is due to release a tranche of over $1 billion to Pakistan.
Pakistan’s central bank foreign exchange reserves stood at $3.814 billion as of Thursday, the state bank said in a statement, up from the previous week.
“...Scheduled debt repayments and a decline in financial inflows amid rising global interest rates and domestic uncertainties continue to exert pressure on FX reserves and the exchange rate,” it said its policy rate statement.
It added that FX reserves remain low and concerted efforts are needed to improve the external position. The Pakistani rupee slumped nearly 6% against the US dollar on Thursday with no clarity on the IMF fund release.
“Today’s slide in the rupee and policy rate hike can be seen as a step towards unlocking the next tranche from the IMF,” said Saad Rafi, head of equities at Al Habib Capital Markets.
The MPC also decided to hold its next meeting on April 4, rather than the previously scheduled April 27.
Copyright Business Recorder, 2023