The State Bank of Pakistan on Monday announced it is maintaining the policy rate at 21 percent, after a meeting of its Monetary Policy Committee (MPC) determined that it is necessary to reduce inflation in the medium-term—barring any unexpected domestic or external shocks.
In a statement, the central bank said the MPC had noted the high inflation rates recorded in April and May, but declared they were within anticipations. It said domestic demand was expected to remain subdued amidst the tightened monetary stance, domestic uncertainty and continuing stress on external account, adding that inflation was seen as having peaked at 38 percent in May 2023, with an expectation of it declining from June onwards.
Noting average inflation had hit 29.2 percent during Jul-May FY23, compared to 11.3 percent in the same period last year, it said food remained its biggest contributor. “Importantly, core inflation maintained its upward trajectory, albeit at a slower pace, mainly indicating the second-round impact of higher food and energy prices and exchange rate depreciation amid still elevated inflation expectations,” it said. “The MPC expects that reduced demand-side pressures and ease in inflation expectations, along with moderating global commodity prices and high base effect, would help bring inflation down from June 2023 onwards,” it said, adding the aim was to bring inflation down to the medium-term target range of 5-7 percent by the end of FY25.
Summarizing multiple important developments since its last meeting, the MPC noted that real GDP growth had decelerated considerably during the outgoing fiscal year, while the current account balance had been in surplus in both March and April, reducing some pressure on foreign exchange reserves. It said the federal budget for FY2023-24 envisaged a “slightly contractionary fiscal stance,” while global commodity prices and financial conditions had eased and were expected to persist at current levels in the near-term.
“On balance, the MPC views the current monetary policy stance, with positive real interest rates on forward looking basis, as appropriate to anchor inflation expectations and to bring down inflation towards the medium term target—barring any unexpected domestic and external shocks,” it said, while stressing this required addressing the prevailing domestic uncertainty and external vulnerabilities.
Referring to the real GDP growth rate of 0.3% against the revised estimate of 6.1% in the last fiscal, the SBP attributed this to “a significant contraction in value addition of industry due to several adverse domestic and external factors” as well as the services sector growing at its slowest pace since the COVID-19 pandemic. “The agriculture sector growth was lower than last year but better than post-flood expectations, as bumper sugarcane and wheat crops and robust growth in the livestock sector largely offset the flood-related damages to cotton and rice crops,” it said, noting the slowdown was in line with prevailing trends, including a decline in volumes of auto, POL and domestic cement sales, and contraction in large-scale manufacturing.
On the current account, the central bank noted the deficit during Jul-Apr FY23 dropped to $3.3 billion, less than a fourth of last year’s deficit. “The policy-induced contraction in imports more than offset the drop in exports and remittances,” it said, adding this had somewhat contained pressures on the foreign exchange reserves and the interbank exchange rate, “which has broadly remained stable since the last MPC meeting.” However, it warned, debt repayments amid lower fresh disbursements and weak investment inflows continue to exert pressure on the reserves. “Going forward, under the baseline assumptions of relatively favorable outlook for commodity prices and moderate domestic economic recovery next year, the MPC views that the current account deficit will broadly remain in check,” it added.
The SBP said the fiscal position had improved in cumulative terms during Jul-Mar FY23, with the fiscal deficit reducing to 3.6 percent of GDP from 3.9 percent last year against a primary balance surplus of 0.6 percent of GDP against a deficit last year. “Notwithstanding this cumulative improvement, there has been some deterioration in fiscal indicators in Q3, largely reflecting an increase in non-interest current expenditures, mainly subsidies, and a significant deceleration in the pace of overall tax revenue,” it said, while warning of an increase to the deficit due to “usual end-year” increase in developmental spending and further slowdown in revenue collection amidst substantial slowdown in domestic economic activity and contraction in imports. The revised estimates show fiscal deficit at 7% and primary deficit at 0.5% of GDP for FY23. “The FY24 budget envisages the fiscal deficit at 6.5% and a primary surplus of 0.4% of GDP,” it said, stressing this required strict adherence to contain inflationary and external account pressures.
The MPC meeting also noted broad money growth decelerated in May 2023 compared to last year, largely due to a substantial fall in private sector credit and a contraction in net foreign assets of the banking system. “While there was an uptick in credit for fixed investment in April, it was significantly lower in cumulative terms during Jul-Apr FY23 compared to the same period last year,” it added.