The State Bank of Pakistan (SBP) on Tuesday raised its benchmark interest rate by 100 basis points, from 20 to 21 percent—the highest level in decades—to anchor “inflation expectations” around the medium-term target and achieve price stability.
In a statement issued after the Monetary Policy Committee (MPC), the central bank noted that inflation in March had hit 35.4 percent and was expected to remain high in the near-term. “However, there are early indications of inflation expectations plateauing, albeit at an elevated level,” it said, stressing that Pakistan’s financial sector remained “broadly resilient” even as economic activity moderated.
Referring to its previous meeting—on March 2—the MPC said it had witnessed three developments for the macroeconomic outlook. “First, the current account deficit has narrowed considerably, more than previously anticipated, mainly on the back of sizable import containment. Nonetheless, the overall balance of payments position continues to remain under stress, with foreign exchange reserves still at low levels. Second, significant progress has been made towards completion of the 9th review under the IMF’s EFF program. Third, recent strains in the global banking system have led to further tightening of global liquidity and financial conditions,” it said, noting these had added to the difficulties of emerging market economies like Pakistan to access international capital markets.
Stating that the MPC considered current monetary policy stance appropriate in this context, the SBP said the hike to the interest rate, coupled with previous accumulated monetary tightening, would help achieve the medium-term inflation target over the next 8 quarters. “However, the [MPC] noted that uncertainties attached with the global financial conditions as well as the domestic political situation, pose risks to this assessment,” it added.
On the real sector, the MPC said data suggested broad-based slowdown in economic activity. “In particular, there has been a significant decline in sales volumes of automobiles and POL in recent months,” it said, adding contraction in large-scale manufacturing had accelerated in January, reducing output. “Reflecting these trends, electricity generation declined for the ninth consecutive month in February,” it said, adding that while cotton production remained per expectation, the wheat production target was likely to be missed. “These developments, combined with the lagged impact of the recent monetary tightening and new fiscal consolidation measures implemented since beginning of March, suggest growth in FY23 will be significantly lower than the post-floods assessment of November 2022,” it warned.
For the external sector, the SPB hailed a current account deficit of “only” $74 million in February 2023, noting the cumulative deficit for the ongoing fiscal was now $3.9 billion, about 68 percent lower than the same period last year. “This mainly reflects the contraction in imports, which continues to outweigh the combined decline in remittances and exports,” it said, adding that workers’ remittances had slightly recovered on month-to-month basis in February, which was expected to continue. “However, despite the lower current account deficit, higher loan repayments relative to disbursements are keeping the foreign exchange reserves under pressure,” it added. The MPC, it said, reemphasized that the early conclusion of the 9th review under the IMF program was critical to rebuilding foreign exchange reserves.
In the fiscal sector, the MPC saw fiscal outcomes from July through January as encouraging in the context of achieving macroeconomic stability. “The fiscal deficit was contained to 2.3 percent of GDP during Jul-Jan FY23 compared to 2.8 percent in the same period last year, while the primary balance posted a surplus of 1.1 percent of GDP against a deficit of 0.3 percent last year,” it said, noting this was achieved on the back of lower subsidies, grants and development spending. “Growth in tax revenues, however, has remained below target, amidst a slowdown in economic activity, reduction in imports and inadequate policy focus on expanding the tax net, while debt servicing has increased,” it stated, warning that delivering the envisaged fiscal consolidation was important to complement the ongoing monetary tightening in order to achieve price stability.
Inflation outlook
According to the MPC, broad money growth showed a slight uptick in February, primarily due to a significant expansion in net domestic assets of the banking system. “This was largely on account of higher public sector borrowing as growth in private sector credit decelerated sharply to 11.1 percent in February 2023 from 18.6 percent in February 2022,” it said. On inflation, the MPC said national CPI inflation of 35.4 percent in March 2023 had resulted in average inflation of 27.3 percent during the first nine months of the ongoing fiscal year. “The MPC noted that the surge in inflation was broad-based, though a large part of it was contributed by food and energy components,” it said, saying this reflected recent increases to taxes and duties, unwinding of untargeted energy subsidies and the recent exchange rate depreciation.
“Importantly, core inflation has risen to 18.6 percent in urban and 23.1 percent in rural baskets, indicating the second-round impacts of the above-mentioned adjustments,” it warned, adding core inflation was partly driven by elevated inflation expectations, as indicated by recent sentiment surveys. “To anchor these expectations, the MPC views its current monetary policy stance as appropriate to keep the real interest rate in positive territory on a forward-looking basis,” it added.