SBP Increases Policy Rate by 1.50%

The State Bank of Pakistan’s (SBP) Monetary Policy Committee (MPC) on Friday raised the policy rate by 150 basis points to 8.75 percent from 7.25 percent, according to a statement issued by the bank.

The hike comes almost two months after the SBP revised its policy rate after keeping it at 7 percent for more than a year.

It bears mentioning that today’s policy revision was brought forward in light of recent unforeseen developments that have affected the outlook for inflation and the balance of payments, and to reduce the uncertainty about the monetary settings in the market.

“With risks rotating from growth to inflation and the current account faster than expected, there is now a need to proceed faster to normalize monetary policy to counter inflation and preserve stability with growth. Today’s rate increase is a material move in this direction”, the central bank’s statement read.

“Looking ahead, the MPC reiterated that the end goal of mildly positive real interest rates remains unchanged, and given today’s move, expects to take measured steps to that end”, SBP concluded in its thread.

MPC Meetings Increased From 6 to 8 Times a Year

“In continuation of efforts to make the process of monetary policy formulation more predictable and transparent in line with international best practices, the State Bank of Pakistan (SBP) has decided to increase the frequency of monetary policy reviews from six (6) to eight (8) times a year. This action will bring the frequency of meetings in line with that in comparable emerging markets. It will also help to enhance the predictability of monetary policy actions”, the bank added.

Accordingly, the schedule for the next five MPC meetings is as follows:

  1. December MPC meeting: Tuesday, 14th Dec 2021
  2. January MPC meeting: Monday, 24th Jan 2022
  3. March MPC meeting: Tuesday, 8th Mar 2022
  4. April MPC meeting: Tuesday, 19th Apr 2022
  5. June MPC meeting: Friday, 10th Jun 2022

In extension, the bank has notified that the advance calendar for the next half-year of MPC meetings will be shared at the time of the June 2022 MPC meeting.

Monetary Policy Statement

“At today’s meeting, the Monetary Policy Committee (MPC) decided to raise the policy rate by 150 basis points to 8.75 percent. This reflected the MPC’s view that since the last meeting, risks related to inflation and the balance of payments have increased while the outlook for growth has continued to improve”, the bank said.

“The heightened risks related to inflation and balance of payments stem from both global and domestic factors. Across the world, price pressures from Covid-induced disruptions to supply chains and higher energy prices are proving to be larger and longer-lasting than previously anticipated. In response, central banks have generally begun to tighten monetary policy to keep inflation expectations anchored”.

“In Pakistan too, high import prices have contributed to higher-than-expected CPI, SPI, and core inflation outturns. At the same time, there are also emerging signs of demand-side pressures on inflation, and inflation expectations of businesses have risen on account of further upside risks from domestic administered prices. With respect to the balance of payments, the current account deficits in September and October have been larger than anticipated, reflecting both rising oil and commodity prices and buoyant domestic demand. The burden of adjusting to these external pressures has largely fallen on the rupee”, the bank added.

“As a result of these developments, the balance of risks has shifted away from growth and toward inflation and the current account faster than expected. Accordingly, the MPC was of the view that there is now a need to proceed faster to normalize monetary policy to counter inflationary pressures and preserve stability with growth. Today’s rate increase is a material move in this direction. Looking ahead, the MPC reiterated that the end goal of mildly positive real interest rates remains unchanged and, given today’s move, expects to take measured steps to that end”.

“In reaching its decision, the MPC considered key trends and prospects in the real, external, and fiscal sectors, and the resulting outlook for monetary conditions and inflation”, the bank remarked.

Economic Analyst A.A.H Soomro tweeted that prospective voters wouldn’t mind the hike if it helps the deflating Rupee in any way.

Soomro told ProPakistani,

The Current Account deficit, worsening inflation outlook & continuous Rupee depreciation has brought hawks back in the room. SBP really trying to curb the demand, stop dollar bleeding & tide the inflation peak over. If this helps in PkR falling back to Rs 170sh & imports stabilizing themselves, then job well done!

Real Sector

The economic recovery underway since the start of FY21 continues, as reflected in most high-frequency indicators of domestic demand―including automobile sales, POL (petroleum, oil, and lubricants) sales, and electricity generation―as well as the strength of imports and tax revenues.

Notwithstanding some moderation in September due to a high base effect and some supply chain disruptions, LSM registered broad-based growth of 5.2 percent (y/y) in Q1-FY22, led by production of consumer goods (both durable and nondurable), construction-allied, and export industries. In agriculture, production levels of all major Kharif crops except cotton are estimated to have reached all-time highs. Cotton production has also rebounded, with arrivals at ginneries growing by 80 percent as of 1st November compared to the same period last season.

Overall, the economic recovery appears increasingly durable and self-sustaining, against the backdrop of rapidly falling Covid cases and the government’s vigorous vaccination roll-out. Looking ahead, rising input costs and normalization of macroeconomic policies are likely to lead to some moderation in the growth of industrial activity. Nevertheless, this could be more than offset by the improved outlook for agriculture, such that risks to the growth forecast of 4-5 percent in FY22 are tilted to the upside.

Persistently high international commodity prices and strong domestic activity kept the current account deficit elevated at $3.4 billion in Q1-FY22. The deficit widened to $1.66 billion in October from $1.13 billion in September due to high energy prices and an uptick in services imports, despite some moderation in nonenergy imports.

While the market-based exchange rate has played its due role as a shock absorber, it has borne a considerable burden in terms of adjusting to the widening current account deficit. The rupee has depreciated by a further 3.4 percent since the last MPC meeting. The US dollar also appreciated against most emerging market currencies since May as expectations of tapering by the Federal Reserve have been brought forward.

However, the fall in the value of the rupee since May has been comparatively large. As other adjustment tools normalize, including interest rates and fiscal policy, pressures on the rupee should abate.

Fiscal Sector

The overall fiscal deficit improved to 0.8 percent of GDP in Q1-FY22 from 1 percent in the same period last year. This was driven by the above-target growth in FBR tax revenues (38.3 percent (y/y)) despite higher refunds and a significant reduction in the sales tax rate on POL. Looking ahead, it will be important to achieve the fiscal consolidation plan in the budget to help restrain domestic demand. A higher-than-planned primary fiscal deficit would likely worsen the outlook for inflation and the current account and would undermine the durability of the recovery.

Monetary and inflation outlook

Real money supply growth has accelerated in recent months to above-trend levels. With the economic recovery on a sound footing, there is a need to pare back this growth as part of the broader move toward normalizing monetary conditions. The MPC noted that the recent increase in banks’ cash reserve requirements would help in this regard.

Inflationary pressures have increased considerably since the last MPC meeting, with headline inflation rising from 8.4 percent (y/y) in August to 9 percent in September and further to 9.2 percent in October, mainly driven by higher energy costs and a rise in core inflation.

Looking ahead, global commodity prices and potential further upward adjustments in administered prices of energy pose upside risks to the average inflation forecast of 7-9 percent in FY22. The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth and stands ready to respond appropriately.

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