The SBP’s policy rate has been increased by 100 basis points to a new all-time high of 21%.
The SBP believes that the most recent increase in interest rates is “sufficient to underpin inflation expectations.”
In an effort to rein in the rising inflation rate, Pakistan’s central bank increased its benchmark policy rate by 100 basis points on Tuesday, bringing it to a record high of 21%.
However, economic growth has been slowed by the historically high policy rate and other fiscal measures like the increase in energy prices, and is now predicted to “be much lower than the post-floods assessment of November 2022 (in FY23).
It has come to light that the central bank had previously predicted GDP growth of over 2% for the current fiscal year 2023.
The policy rate hike was in line with market forecasts, which called for a rise of 100–200 basis points.
State Bank of Pakistan (SBP) tweeted, “MPC (monetary policy committee) regards today’s decision, combined with the cumulative monetary tightening so far, as appropriate to anchor inflation expectations around its medium-term objective — barring any unanticipated shock.”
The March 2023 inflation rate of 35.4% was the highest level in six decades. According to forecasts, it will reach a maximum of 37% to 40% in April or May of 2023.
Inflation for the first three months of FY23 averaged 27.3%. The government bank remarked, “The increase in inflation was widespread, though the cost of food and energy products contributed significantly to the overall trend. This reflects the trickle-down effect of tax and duty hikes, the elimination of wasteful energy subsidies, and the recent devaluation of the currency exchange rate.”
Specifically, “core inflation has risen to 18.6 percent in urban and 23.1 percent in rural baskets, demonstrating the second-round consequences of the aforementioned modifications,” they wrote.
To recommence its $6.5 billion loan program, however, the central bank has raised rates on the advice of the International Monetary Fund, according to experts. Otherwise, the exercise of rate-hike has become moot in terms of bringing the rising inflation under control, as demand for bank loans from enterprises in the private sector has already dried up.
When asked about the importance of finishing the ninth review under the IMF programme as soon as possible, the central bank “reemphasized that the early conclusion of the FX (foreign exchange) reserve buffers is vital.”
With low foreign exchange reserves, continued debt repayments, and recent tightening of global financial conditions, the central bank stated in its monetary policy statement that external account vulnerabilities persist despite the recent substantial reduction in the current account deficit.
At present, we only have $4.24 billion in reserves. Pakistan, on the other hand, is expected to repay its $4.5 billion in external debt within the next three months (Apr-Jun 2023). But, the central bank hoped that the government would be able to refinance half of the loans, reducing the amount it would have to pay in the next three months from $2.2 billion to just $1.2 billion.
Three significant developments since the March MPC meeting that could affect the macroeconomic outlook were highlighted by SBP. The current account deficit has shrunk first, and much more so than was expected. This is mostly due to significant reductions in imported goods. Foreign exchange reserves are remained at low levels, and the overall balance of payments position remains stressed.
However, at a briefing for analysts on the latest monetary policy announcement, SBP Governor Jameel Ahmed predicted that the current account deficit (CAD) will total $6 billion in FY23. The bank had previously estimated CAD to be approximately $9 billion.
Second, the ninth EFF (extended financial facility) programme assessment required by the IMF is nearing completion.
Ahmed remained optimistic that the government would be able to restart the IMF loan program soon. As a result, Pakistan would be able to have access to substantial foreign financing. During a summit in Geneva in early 2023, international creditors promised $9 billion to help Pakistan recover from a devastating flood.
Finally, international banking stresses of late have tightened international liquidity and financial circumstances. As a result, “access to foreign finance markets has become even more challenging for emerging market nations like Pakistan.”
The Monetary Policy Committee thinks the current stance is acceptable, and they want you to know that today’s decision, combined with the prior accumulated monetary tightening, will help them hit their medium-term inflation objective in 8 quarters. The committee did, however, point out that “uncertainties linked with global financial conditions and the domestic political environment, offer dangers to our evaluation.”
A slowing economy:
According to SBP, incoming data on economic activity still shows a widespread decline. Particularly, sales of autos and petroleum and oil products (POL) have dropped dramatically in recent months.
Large-Scale Manufacturing (LSM) also saw a year-over-year decline of 7.9% in January. Total LSM output for the first seven months of FY23 (Jul-Jan) is down 4.4% compared to the same period last year.
Electrical output dropped in February for the ninth month in a row, reflecting similar tendencies.
In agriculture, reports of cotton harvests have been consistent with expectations (low output), while reports of wheat harvests indicate that targets are likely to be missed.
As a result of “these developments,” SBP predicted that “growth in FY23 will be significantly lower than the post-floods assessment of November 2022.” This prediction was based on the lag between the impact of recent monetary tightening and new fiscal consolidation measures implemented since the beginning of March and the start of FY23.
Despite a decline in economic activity, a drop in imports, and insufficient governmental focus on broadening the tax net, growth in tax receipts has stayed below target, “while debt servicing has soared.”
Compared to the same month last year, the current account deficit was 68% less at $74 million in February 2023, bringing the cumulative deficit for July through February of FY23 to $3.9 billion.
The foreign exchange reserves remain under strain despite the narrowing current account deficit.