MPC notes Pakistan is facing large negative income shock from high inflation with increases in utility prices, taxes n Adjustment is difficult but necessary in Pakistan.
KARACHI – State Bank of Pakistan (SBP) Thursday increased its policy rate (interest) by 125 basis points to 15 percent.
SBP’s Acting Governor Dr Murtaza Syed made this announcement during a press conference at the SBP main building after MPC meeting in Karachi. Dr Murtaza Syed said that the most important objective behind the move was to control spiraling inflation. The policy statement says that the Monitory Policy Committee (MPC) decided to enhance the policy rate to 15% from 13.75 % . And, as foreshadowed in the last monetary policy statement, the interest rates on Export Financing Scheme and Long-Term Financing Facility loans are now being linked to the policy rate to strengthen monetary policy transmission.
Since the last meeting, the MPC noted the following encouraging developments : the unsustainable energy subsidy package was reversed and fiscal year 2022-23 Budget centered on strong fiscal consolidation was passed.
This has paved the way for completion of the on-going review of the IMF program, which will ensure that tail risks associated with meeting Pakistan’s external financing needs are averted.
$2.3 billion commercial loan from China helped provide support to foreign exchange reserves, which had been falling since January due to current account pressures, external debt repayments and paucity of fresh foreign inflows. Third, economic activity remains robust, with the momentum of the last two years of near 6 percent growth carrying into the start of financial year 2022-23.
As a result, Pakistan faces a significantly lower trade-off between growth and inflation than many countries where the post-Covid recovery has not been as vigorous. However, he mentioned , several adverse developments have overshadowed this positive news. Globally, inflation is at multi-decade highs in most countries and central banks are responding aggressively, leading to depreciation pressure on most emerging market currencies. This strong monetary tightening has occurred despite concerns about a slowdown in global growth and even recession risks, highlighting the primacy that central banks are placing on containing inflation at this juncture.
Domestically, as energy subsidies were reversed, both headline and core inflation increased significantly in June, rising to a 14-year high. Inflation expectations of consumers and businesses also rose markedly.
At the same time, the current account deficit unexpectedly spiked in May and the trade deficit continued its post-March widening trend to reach a 7-month high in June, on burgeoning energy imports. As a result, FX reserves and the Rupee remained under pressure, further worsening the inflation outlook.
Against this challenging backdrop, the MPC noted the importance of strong, timely and credible policy actions to moderate domestic demand, prevent a compounding of inflationary pressures and reduce risks to external stability. Like most of the world, Pakistan is facing a large negative income shock from high inflation and necessary but difficult increases in utility prices and taxes.
Without decisive macroeconomic adjustments, there is a significant risk of substantially worse outcomes that would compromise price stability, financial stability and growth. This could take the form of runaway inflation, FX reserve depletion and the need for sudden and aggressive tightening actions later that would be significantly more disruptive for economic activity and employment.
Adjustment is difficult but necessary in Pakistan, as it is all over the world. However, in the interest of social stability, the burden of this adjustment must be shared equitably across the population, by ensuring that the relatively well-off absorb most of the increase in utility prices and taxes while well-targeted and adequate assistance is provided to the more vulnerable.
— Under the MPC’s baseline outlook, headline inflation is likely to remain elevated around current levels for much of fiscal year 2022-23 before falling sharply to the 5-7 percent target range by the end of fiscal year 2023-24, driven by tight policies, normalisation of global commodity prices, and beneficial base effects. While risks exist on both sides, those of significantly higher inflation dominate, prompting today’s rate increase.
Going forward, the MPC will remain data-dependent, paying particularly close attention to month-on-month inflation, the evolution of inflation expectations and global commodity prices, as well as developments on the fiscal and external fronts.
Real Sector : Pakistan’s strong economic rebound from Covid continues, with the level of output surpassing pre-pandemic levels, unlike in many other emerging markets. The needed moderation in economic activity that was occurring through financial year 2021-22 in response to monetary tightening has stalled in the last three months, fueled by an unwarranted fiscal expansion.
Most demand indicators suggest robust growth since the last MPC—sales of cement, petroleum products and automobiles increased month-on-month basis and growth in large scale manufacturing remains high.
Looking ahead, growth is expected to moderate to 3-4 percent in financial year 2022-23, on the back of monetary tightening and fiscal consolidation, helping to close the positive output gap and diminish demand-side pressures on inflation. This will pave the way for higher growth on a more sustainable basis.
External Sector : After moderating in the previous three months, the current account deficit rose to $1.4 billion in May, on the back of lower exports and remittances partly due to the Eid holiday.
Based on PBS data, the trade deficit rose to $4.8 billion in June, more than $1.7 billion higher than its February low. While non-energy imports have continued to moderate in the last three months on the back of curtailment measures by the government and the SBP, this decline has been more than offset by the significant increase in energy imports, which rose from a low of $1.4 billion in February to an estimated record high of $3.7 billion in June.
He said, this partly reflects higher prices, significantly higher volumes of petroleum also played a significant role. Without prompt additional measures to curtail energy imports—for instance through early closure of markets, reduced electricity use by residential and commercial customers, and greater encouragement of work from home and car pooling—containing the trade deficit could become challenging.