The State Bank of Pakistan on Friday increased the policy rate by 50 basis points to 6.5% for the next two months. In a policy statement, the bank said that that inflation may rise in the coming months. “Average of YoY Non-Food Non-Energy NFNE-core inflation during the last two months has risen to 6.4%, which reflects the building up of inflationary pressures in the economy,” the statement read. “Significant change in the outlook for international oil prices with its impact on upward adjustments in domestic oil prices, a strong demand, the lagged pass-through of exchange rate adjustments, food inflation maintaining its current course and the stoking of survey-based measures of inflationary expectations will largely determine the inflation path in the remaining period of FY18 and for FY19,” it added. The SBP said that the headline CPI inflation remains moderate averaging 3.8% during the first 10 months of FY18, mainly owing to low food inflation. The average food inflation clocked in 1.8% during Jul-Apr FY18, whereas the year-on-year food inflation was close to zero in March and April 2018, it added. Pakistan’s economic growth is provisionally estimated to achieve a 13-year high level of 5.8% for FY18. Concurrently, headline inflation remains moderate and is expected to stay well below the annual target of 6%, according to the SBP. The bank said since the last meeting, in MPC’s assessment the balance of risks to the sustainability of the healthy-growth-low-inflation nexus have shifted due to the following reasons. “First, the balance-of-payments picture, despite an increase in exports and some deceleration in imports, has further deteriorated due to a sharp increase in international oil prices and limited financial inflows to date. Second, the revised estimate for fiscal deficit stands at 5.5% of GDP as compared to initial target of 4.1% for FY18, reflecting a significantly higher level of fiscal expansion than previously anticipated. These twin deficits depicting the elevated aggregate demand in the country are adversely affecting the near-term macroeconomic stability.” “Turning to the supply side, the sector has posted a broad-based healthy growth in FY18. Growth in major crops and a modest increase in livestock and agriculture sector has not only recorded a notable improvement over the last year but also surpassed the annual growth target of 3.5%. Industrial sector grew by 5.8%, primarily because of vibrant construction activity and notable improvement in large-scale manufacturing,” the statement said. “These gains in the commodity-producing sector along with growing aggregate demand have pushed the growth in services to 6.4%, the SBP said, adding, “Keeping in view this strong growth momentum and the upcoming investments in auto and construction allied industries, the government has set the real GDP growth target of 6.2% for FY19. However, SBP’s assessment of overall macroeconomic picture suggests that this target is ambitious and would critically depend on managing the growing pressures on the external account, while ensuring that average inflation is contained close to its target in FY19.” The bank said barring the risks associated with growth and recovering commodity prices, trends are likely to persist in the coming months of FY19 as the private sector continues to adjust its funding needs in line with the requirements of the growing economy, especially related to the CPEC investments. “On the external front, the current account deficit widened to $14 billion during 10 months of FY18, which is 1.5 times the level of deficit realized during the same period last year. Despite a strong recovery in exports and a moderate increase in workers’ remittances, the growing imports to support higher economic activity and the sharp increase in oil prices have pushed the current account deficit to a higher level,” the bank said. “In the absence of sufficient projected financial flows, a portion of this higher current account deficit was managed by using country’s own resources during FY18,” the bank noted. “Reflecting the increasing pressures in the external sector, the PKR depreciated by 9.3% against the USD up till 24th May 2018. The near-term sustainability of prevailing higher current account deficit critically depends on the realization and further mobilization of financial flows. The need for deep-rooted structural reforms to improve the country’s competitiveness can hardly be over-emphasized for medium to long-term sustainability of balance of payments,” according to the SBP. Published in Daily Times, May 26th 2018.