The State Bank of Pakistan (SBP) on Monday maintained the benchmark interest rate at 15 percent for the next seven weeks, noting this was intended to manage inflation and maintain growth in the wake of devastating floods.
“Since the last meeting, the Monetary Policy Committee (MPC) noted the deceleration in economic activity as well as the decline in headline inflation and current account deficit,” it wrote in a series of tweets accompanying the announcement. “It also noted that the recent floods have altered the macroeconomic outlook and a fuller assessment of their impact is underway,” it said, adding that economic growth could fall to around 2 percent in the ongoing fiscal year against an earlier forecast of 3-4 percent.
“Despite lower demand-side pressures, higher food prices could raise average headline inflation in FY23 somewhat above the pre-flood projection of 18-20 percent,” it said. “With pressures from higher food and cotton imports and lower textile exports largely likely to be offset by slower domestic demand and lower global commodity prices, the current account deficit in FY23 is expected to remain close the previously forecast 3% of GDP,” it added.
According to the Monetary Policy Statement issued by the central bank, its desired moderation in economic activity had become more visible and entrenched, signaling that the tightening measures—imposed to curb ‘overheating’ of the economy—implemented over the last year were gaining traction. “After peaking in August, as expected, headline inflation fell last month due to an administrative cut in electricity prices. However, core inflation continued to drift upwards in both rural and urban areas,” it added.
“The current account and trade deficits narrowed significantly in August and September, respectively, and the rupee has recouped some of its losses following the recent depreciation,” it noted, adding the combined 7th and 8th review under the ongoing IMF program had successfully completed on Aug. 29, with the release of a tranche of $1.2 billion
On the economic slowdown, the central bank noted most demand indicators were lower in both July and August than the same period last year—including sales of cement, POL, and automobiles. On the supply side, it said, electricity generation declined for the third consecutive month in August, falling by 12.6 percent year-on-year. “In July, [large-scale manufacturing] declined by 1.4 percent (year-on-year), its first contraction in two years, largely driven by broad-based deterioration in domestically-oriented sectors,” it said, warning the floods were likely to adversely affect the output of cotton, rice and livestock this year.
The MPC said the current account deficit had shrank for the second consecutive month in August to only $0.7 billion, almost half the level in July, with the trade deficit contracting by 19.7 percent (month-to-month) and 30.6 percent (year-on-year) to reach $2.9 billion, reflecting a decline in both energy and non-energy imports amid stable exports. It said the current account would likely be boosted with international assistance in the form of current transfers due to this year’s floods. “Given secured external financing and additional commitments in the wake of the floods, FX reserves should improve through the course of the year,” it added.
On the fiscal sector, the MPC said the fiscal deficit had fallen to 0.3 percent of GDP while the primary balance recorded a surplus of 0.2 percent of GDP. “This improvement was largely due to higher FBR tax revenues as well as a decline in government spending,” it said.
On inflation, the MPC said it had reduced by over 4 percent in September to 23.2% (year-on-year), driven by a reduction in electricity prices due to an administrative intervention. However, it said, this was accompanied by an increase to core and food inflation. “Looking ahead, the supply-shock to food prices from the floods is expected to put additional pressure on headline inflation in the coming months. Nevertheless, headline inflation is still projected to gradually decline through the rest of the fiscal year, particularly in the second half,” it said, adding it should fall toward the upper range of 5-7 percent. “Curbing food inflation through administrative measures to resolve supply-chain bottlenecks and any necessary imports should be a high priority,” it stressed.
“The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth,” it added.