SBP jacks up the key rate as the rupee nosedives.
As Pakistan works feverishly to satisfy IMF requirements, the key policy rate was increased by 300 basis points to 20%.
On a day when the rupee was brutally pounded against the dollar, the State Bank of Pakistan (SBP) aggressively increased the key policy rate by 300 basis points, sparking concerns that the economy would see negative growth this fiscal year.
As the government pushed to meet the requirements set forth by the International Monetary Fund (IMF) for the resumption of its loan programme, the central bank made a decision at a previously scheduled meeting that exceeded the market forecast of a rate increase of 200 basis points.
The rate increase also comes one day after data from the Pakistan Bureau of Statistics (PBS) revealed that inflation had soared to a level of 31.5%, a five-decade high, sparking concerns that the nation was rapidly moving towards hyperinflation.
20% is the highest policy rate in more than 26 years. In its meeting today, the Monetary Policy Committee (MPC) decided to hike the policy rate by 300 basis points to 20%, according to a statement from the SBP.
“In light of recent external and budgetary adjustments, this decision reflects a worsening of the inflation outlook and expectations. This scenario, in the MPC’s opinion, calls for a robust policy response to fix inflation expectations at the medium-term goal of five to seven percent.
In contrast to its November 2022 prediction of 21-23% for the year, the central bank has raised its prognosis for inflation reading to 27-29% for the current fiscal year ending June 30, 2023.
After the government increased energy tariffs, enacted additional levies through the mini-budget, and allowed the native currency to dramatically depreciate in recent days and weeks to unlock the $6.5 billion IMF programme, the government has re-estimated the rise in inflation reading.
In the interbank market on Thursday, the rupee fell by almost 7% in a single day, reaching a record low of about Rs285 against the US dollar. The cost of 24-karat gold per tola also rose significantly by Rs9,400 to Rs206,500.
Together with the terrible floods last year and the nation’s high political unpredictability, demand-cutting tactics have been driving up prices and endangering economic growth.
The growth for the year was predicted by the regional research firms to be between 1.25% and slightly negative. The SBP did not provide a prognosis in the most recent release, but it had forecast in January a growth rate of less than 2% for FY23 as opposed to 2% in November 2022.
The MPC meeting was originally scheduled to take place on March 16, but the SBP moved it up. Since price stability is essential for achieving long-term economic growth, central banks around the world have access to the interest rate as a tool to manage inflation.
In order to increase foreign exchange reserves and prevent the impending default on foreign debt repayments, the IMF had earlier requested that the government increase the interest rate for the reactivation of the $6.5 billion loan programme.
The MPC had emphasised short-term risks to the inflation forecast from external and fiscal adjustments at its most recent meeting in January. The majority of these risks have manifested and are largely reflected in February’s inflation outturns, according to the SBP.
In February 2023 compared to the same month the previous year, core inflation increased to 17.1% in urban areas and 21.5% in rural areas, according to the SBP’s most recent monetary policy statement (MPS).
“The recent fiscal adjustments [increase in tariffs and mini-budget] and the weakening of the rupee-dollar exchange rate have significantly deteriorated the near-term inflation outlook and substantially increased inflation expectations,” the statement continued.
The committee anticipated that inflation would continue to climb over the next months as the effects of the fiscal and monetary policy [policy rate] adjustments materialised before starting to decline, albeit gradually.
On the external front, the MPC underlined that risks persisted despite a sizable reduction in the current account deficit (CAD).
The CAD dropped to $242 million in January 2023, which was its lowest amount since March 2021. At $3.8 billion in Jul-Jan FY23, the CAD is down 67% overall from the same time previous year.
“Despite this improvement, scheduled debt repayments and a decrease in financial inflows amid rising global interest rates and internal uncertainty, continue to exert pressure on FX [foreign exchange] reserves and the [rupee-dollar] exchange rate,” according to the report.
The MPC underlined that the foreign exchange reserves, which are now at $3.8 billion, remained low and that coordinated efforts were required to strengthen the external position, according to the SPB’s policy statement.
The MPS said, “In this context, the completion of the ongoing 9th review under the IMF’s EFF [Extended Fund Facility or the loan programme] will help address near-term external sector problems.
The SBP also emphasised the urgent need for energy conservation measures to relieve external account strain and meet the import demands of other sectors. Around one-fourth of the overall import expenditure is made up of energy imports.
Recent fiscal initiatives, such as an increase in the general sales tax (GST) and excise taxes, a reduction in subsidies, changes to energy prices, and the austerity drive, are anticipated to assist manage the otherwise expanding fiscal and primary deficits, according to the SBP.
The statement continued, “As underlined in past announcements, the projected fiscal consolidation is crucial for the stability of the economy and will support the ongoing monetary tightening in reducing inflation over the medium term.
The central bank emphasised that any serious budgetary slippages will weaken the efficacy of monetary policy in the context of achieving the price stability target.
Because that financial institutions were generally properly funded, the risks to financial stability remained controlled, according to the SBP. “On the growth [front], there is a trade-off, though.”
Yet, the MPC repeated its prior assertion that reducing inflation would be cheaper in the short term than allowing it to persist over time.
According to the central bank, the most recent policy rate increase of 300 basis points “has pushed the real interest rate in positive territory on a forward-looking basis,” adding that this would help stabilise inflation expectations and drive inflation to the medium-term target of 5-7% by the end of fiscal year 2025, barring any unforeseen future shocks.
Moreover, the following MPC meeting has been moved up from April 27 to April 4 in 2023.
