SBP raises interest rate to 15pc as inflation bites

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.