SBP increases key interest rate by 150bps to 12.25%

In order to address underlying inflationary pressures from higher headline/core inflation outturns, exchange rate depreciation, elevated fiscal deficit and potential adjustments in utility tariffs, the State Bank of Pakistan (SBP) on Monday increased the policy rate by 150 bps to 12.25% effective from May 21 (Tuesday).

The SBP said inflationary pressures are likely to continue for some time and the average headline CPI inflation is expected to be in the range of 6.5-7.5% in FY19 and anticipated to be considerably higher in FY20.

The SBP’s estimates show that economic growth is expected to slow in FY19 but rise modestly in FY20. “This slowdown is mostly due to lower growth in agriculture and industry. More than two-thirds of real GDP growth in FY19 is expected to come from services,” the bank said. “Going forward, some gradual recovery in economic activity is expected on the back of improved market sentiment in the context of the IMF supported program, a rebound in the agriculture sector and government incentives for export-oriented industries,” it hoped. Recent trade account indicators suggest the export volumes have begun to grow although total export receipts have not grown due to unfavourable prices, it added.

The SBP said despite improvement in the current account and a noticeable increase in official bilateral inflows, the financing of the current account deficit remained challenging. “Consequently, reserves declined to US$ 8.8 billion as of May 10, 2019, from US$ 10.5 billion at end-March 2019. The exchange rate also came under pressure in the last few days,” the central bank said. In SBP’s view, the recent movement in the exchange rate reflects the continuing resolution of accumulated imbalances of the past and some role of supply and demand factors. “SBP will continue to closely monitor the situation and stands ready to take measures, as needed, to address any unwarranted volatility in the foreign exchange market,” the statement added.

The bank said the current level of reserves is below standard adequacy levels (equal to three months of imports cover). Deep structural reforms are required to improve productivity and competitiveness of export-oriented sectors and improve the trade balance, it added.

“The overall fiscal deficit is likely to be considerably higher during Jul-Mar FY19 as compared to the same period last year due to a shortfall in revenue collection, higher than budgeted interest payments and security related expenditures,” the statement said. “From a monetary policy perspective, a growing portion of the fiscal deficit has been financed through borrowings from SBP. In absolute terms, the government borrowed Rs 4.8 trillion from SBP during July 1, 2018, to May 10, 2019, which is 2.4 times the borrowing during the same period last year. A major portion of this borrowing from the SBP (Rs 3.7 trillion) reflects a shift away from commercial banks which were reluctant to lend to the government at prevailing rates. The resulting increase in monetization of the deficit has added to inflationary pressures,” it added.

“Despite the recent tightening of monetary policy, private sector credit rose 9.4% during July 1, 2018, to May 10, 2019. Much of the increase in credit was for working capital needs due to higher input prices,” the bank said. “The expansionary impact of higher government borrowing and private sector credit on broad money supply (M2) was partly offset by a contraction in net foreign assets of the banking sector,” he added.

According to the SBP, the consumer price index (CPI) rose 9.4% in March 2019 and 8.8% in April 2019 on a y-o-y basis. “Average headline CPI inflation reached 7.0% in Jul-Apr FY19 compared to 3.8% in the same period last year,” it said. “Moreover, the annualised headline month-on-month inflation has risen considerably in the last three months due to the recent hike in domestic fuel prices and rising food prices and input costs. As such, inflationary pressures are likely to continue for some time,” it continued. “The most recent IBA-SBP consumer confidence survey also shows that most households expect higher inflation during the next six months. This inflation outlook is subject to a number of upside risks from an expected rationalisation of taxes in the upcoming budget, potential adjustments in electricity and gas tariffs, and volatility in international oil prices,” it further said. “The inflation outlook suggests a fall in real interest rates on a forward-looking basis,” it added.

Earlier this month, Dr Reza Baqir, a long-time economist with the International Monetary Fund (IMF), was appointed SBP governor for a period of three years. The senior economist of Pakistani origin replaced Tariq Bajwa, who was unexpectedly removed from the post.

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