Amid rising inflation, an elevated fiscal deficit and low foreign exchange reserves, the State Bank of Pakistan (SBP) on Friday decided to raise the key interest rate by 150 bps to 10%. The newly announced interest rate will be effective from Monday for the next two months. Also, the central bank revised down FY19 GDP growth target to 4% from 5% owing to lagged impact of monetary tightening, slowdown in agricultural sector and resultant slump in services sector growth. The bank said the economic data shows positive impact of recent stabilization measures has started to materialize gradually. Particularly, the current account deficit is showing early signs of improvement. However, the near term challenges to Pakistan’s economy continue to persist. It is to be noted the SBP has increased interest rate by a cumulative 425 basis points since January 2018. The SBP projected average headline CPI inflation for FY19 in the forecast range of 6.5-7.5%, above the annual target of 6%. Taking a lead from the recent large-scale manufacturing data, economic activity is expected to witness a notable moderation during FY19 – reflecting a short-term cost of pursuing macroeconomic stability, the bank added. The bank said the lagged impact of the 275 basis point increase in the policy rate since January 2018 and other policy measures are likely to contain domestic demand during the current fiscal year. The slowdown in commodity producing sectors is expected to limit the expansion in the services sector as well. In this backdrop, SBP projected the real GDP growth for FY19 at slightly above 4%. Despite some improvement in trade balance, SBP’s net liquid foreign exchange reserves remained under pressure falling to US$8.1 billion as of November 23, 2018, from US$9.8 billion at the end of FY18. The Monetary Policy Committee (MPC) of SBP noted that continued inflationary pressure (and rising inflationary expectations) needs to be checked as real interest rates remain low, the current account deficit still high and the fiscal deficit remains elevated. It said the unfolding global developments, particularly the gradual but consistent normalization of monetary policy in the developed economies, demands proactive domestic monetary management. In light of the current and evolving macroeconomic situation, the committee was of the view that further consolidation is required to ensure macroeconomic stability and therefore decided to raise the SBP policy rate by 150 bps to 10% effective December 3, 2018. On strategies to overcome the country’s recurrent balance-of-payment challenges in the medium term, the committee opined that with exchange rate reflecting a demand-supply gap in the foreign exchange market, the adoption of a flexible inflation targeting framework will help anchor inflation expectations, improving productivity and competitiveness of exports will have to play a prominent role to reduce the external trade deficit; and the fiscal policy will have to be proactive and play a supportive role to generate conditions for a sustainable growth path. Published in Daily Times, December 1st 2018.