KARACHI ( July 7, 2022). As was expected the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) on Thursday decided to raise the policy rate by 125 basis points to 15 percent. In addition, as foreshadowed in the last monetary policy statement, the interest rates on EFS and LTFF loans are now being linked to the policy rate to strengthen monetary policy transmission while continuing to incentivize exports by presently offering a discount of 500 basis points relative to the policy rate.
This combined action continues the monetary tightening underway since last September, which is aimed at ensuring a soft landing of the economy amid an exceptionally challenging and uncertain global environment. It should help cool economic activity, prevent a de-anchoring of inflation expectations and provide support to the Rupee in the wake of multi-year high inflation and record imports.
Since the last meeting, the MPC noted three encouraging developments. First, the unsustainable energy subsidy package was reversed and an FY23 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. Second, a $2.3 billion commercial loan from China helped provide support to FX 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 FY23. 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, 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 FY23 before falling sharply to the 5-7 percent target range by the end of FY24, driven by tight policies, normalization 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.
Pakistan Sugar Mills Association (PSMA ) senior vice president , Iskander A Khan, in his comments on jacking up of interest rate by SBP said ” The increase in interest rate will have negative impact on industry and in total contrast to the SBP claims it will result in further hike in inflation, Surge in interest rate will also make difficult for private sector industries to give increment to their staff besides discouraging investment in industrial sector”.
Dr Abid Suleri , executive director Sustainable Development Policy Institute (SDPI) in his comments said keeping in view, the historic consumer price inflation (21.3 %) a hike in policy rate was expected . While increasing the policy rate was the only option with State Bank of Pakistan to contain the depreciation of value of the rupee , the problem is that even this high interest rate will not curb the inelastic demand for energy and food. As the governor SBP himself said the average inflation this year would remain 20 % , the question is whether SBP would keep on increasing the policy rate . If yes, hen how the cost of doing business would be reduced .
