SBP Makes Steep Hike of 150 Bps in Policy Rates to 12.25%

State Bank of Pakistan (SBP) has dropped a bomb of 1.5 % hike of the policy rate on the economy, which will adversely impact on the cost of doing business – though move was expected Reza Baqir, an ex-official of International Monetary Fund, joined Central Bank as its Governor.

The policy rate jumped to 12.25 percent from 10.75 percent in one-go. Previously 75 basis points (0.75 %) were increased in the two phase during 2019.

Monetary Policy Committee of the central bank stated that further policy measures are required to address underlying inflationary pressures from higher recent month-on-month headline and core inflation outturns; recent exchange rate depreciation; an elevated fiscal deficit and its increased monetization, and potential adjustments in utility tariffs.

Economic Indicators At Glance

Despite the improvement in the current account and a noticeable increase in official bilateral inflows, the financing of the current account deficit remained challenging. Consequently, reserves declined to US$ 8.8 billion as of 10th May 2019 from US$ 10.5 billion at end-March 2019.

The overall fiscal deficit is likely to be considerably higher during Jul-Mar FY19 as compared to the same period last year due to a shortfall in revenue collection, higher than budgeted interest payments and security related expenditures.

From a monetary policy perspective, a growing portion of the fiscal deficit has been financed through borrowings from SBP

The exchange rate also came under pressure in the last few days. In SBP’s view, the recent movement in the exchange rate reflects the continuing resolution of accumulated imbalances of the past and some role of supply and demand factors.

Furthermore, the current level of reserves is below standard adequacy levels (equal to three months of imports cover). As noted in previous MPC statements, deep structural reforms are required to improve productivity and competitiveness of export-oriented sectors and improve the trade balance.

Key Developments Since The Last MPC Statement

There have been three notable developments since the last Monetary Policy Committee meeting in March 2019.

First, the government of Pakistan has reached a staff-level agreement with the International Monetary Fund for 39-month long Extended Fund Facility of around US$ 6.0 billion. The program is designed to restore macroeconomic stability and support sustainable economic growth, and is expected to unlock considerable additional external financing.

Second, trends in government borrowing reflect a widening fiscal deficit during the first nine months of FY19 when compared to the same period in FY18. In addition, a greater reliance on central bank financing of the deficit has acted to dilute the impact of previous monetary tightening.

Finally, since the last MPC, the exchange rate has depreciated by 5.93 percent to PKR 149.65 per USD, at the close of 20th May 2019, reflecting a combination of underlying macroeconomic factors and market sentiment considerations.

Slow Economic Recovery On The Cards

SBP’s estimates show that economic growth is expected to slow in FY19 but rise modestly in FY20. This slowdown is mostly due to lower growth in agriculture and industry. More than two-thirds of real GDP growth in FY19 is expected to come from services.

Going forward, some gradual recovery in economic activity is expected on the back of improved market sentiment in the context of the IMF supported program, a rebound in the agriculture sector and government incentives for export-oriented industries.

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