Tag: Monetary Policy

KARACHI: State Bank of Pakistan (SBP) on Friday raised the benchmark interest rate by 100 basis points to 16 per cent owing to inflationary pressure and risks to financial stability.

The SBP said that the monetary policy committee in its meeting on November 25, 2022 decided to raise the policy rate by 100 basis points to 16 per cent.

This decision reflects the MPC’s view that inflationary pressures have proven to be stronger and more persistent than expected. It is aimed at ensuring that elevated inflation does not become entrenched and that risks to financial stability are contained, thus paving the way for higher growth on a more sustainable basis.

READ MORE: SBP keeps policy rate unchanged at 15% amid economic deceleration

Amid the on-going economic slowdown, inflation is increasingly being driven by persistent global and domestic supply shocks that are raising costs. In turn, these shocks are spilling over into broader prices and wages, which could de-anchor inflation expectations and undermine medium-term growth. As a result, the rise in cost-push inflation cannot be overlooked and necessitates a monetary policy response.

The MPC noted that the short-term costs of bringing inflation down are lower than the long-term costs of allowing it to become entrenched. At the same time, curbing food inflation through administrative measures to resolve supply-chain bottlenecks and any necessary imports remains a high priority.

READ MORE: SBP keeps benchmark rate unchanged at 15% amid rising inflation

Since the last meeting, the MPC noted three key domestic developments. First, headline inflation increased sharply in October, as the previous month’s administrative cut to electricity prices was unwound. Food prices have also accelerated significantly due to crop damage from the recent floods, and core inflation has risen further.

Second, a sharp decline in imports led to a significant moderation in the current account deficit in both September and October. Despite this moderation and fresh funding from the ADB, external account challenges persist. Third, after incorporating the Post-Disaster Needs Assessment of the floods and latest developments, the FY23 projections for growth of around 2 percent and a current account deficit of around 3 percent of GDP shared in the last monetary policy statement are re-affirmed. However, higher food prices and core inflation are now expected to push average FY23 inflation up to 21-23 percent.

READ MORE: Poll sees no policy rate change in August 22, 2022 meeting

Economic activity has continued to moderate since the last MPC meeting on account of transient disruptions from floods and on-going policy and administrative measures. In October, most demand indicators showed double-digit contraction on a yearly basis—including sales of cement, POL, and automobiles.

On the supply side, electricity generation declined for the fifth consecutive month, falling by 5.2 percent (y/y). In the first quarter of FY23, LSM production was flat relative to last year, with only export-oriented sectors contributing positively. In agriculture, latest estimates suggest sizeable output losses to rice and cotton crops from the floods which, together with tepid growth in manufacturing and construction, will weigh on growth this year.

READ MORE: Pakistan hikes key policy rate by 125 basis points to 15%

The current account deficit continued to moderate during both September and October, reaching $0.4 and $0.6 billion, respectively. Cumulatively, the current account deficit during the first four months of FY23 fell to $2.8 billion, almost half the level during the same period last year. This improvement was mainly driven by a broad-based 11.6 percent fall in imports to $20.6 billion, with exports increasing by 2.6 percent to $9.8 billion.

On the other hand, remittances fell by 8.6 percent to $9.9 billion, reflecting a widening gap between the interbank and open market exchange rate, normalization of travel and US dollar strengthening. On the financing side, inflows are being negatively affected by domestic uncertainty and tightening global financial conditions as major central banks continue to raise policy rates. The financial account recorded a net inflow of $1.9 billion during the first four months of FY23, compared to $5.7 billion during the same period last year. Looking ahead, higher imports of cotton and lower exports of rice and textiles in the aftermath of the floods should be broadly offset by a continued moderation in overall imports due to the economic slowdown and softer global commodity prices.

As a result, the current account deficit is expected to remain moderate in FY23, with FX reserves gradually improving as anticipated external inflows from bilateral and multilateral sources materialize. If the recent decline in global oil prices intensifies or the pace of rate hikes by major central banks slows, pressures on the external account could diminish further.

Despite the budgeted consolidation for FY23, fiscal outcomes deteriorated in Q1 relative to the same period last year. The fiscal deficit increased from 0.7 to 1 percent of GDP, with the primary surplus declining from 0.3 to 0.2 percent of GDP.

This deterioration was largely due to a decline in non-tax revenues and higher interest payments. At the same time, growth in FBR tax revenues more than halved to 16.6 percent during the first four months of FY23. In response to the floods, the government has implemented a number of relief measures for the agriculture sector, including mark-up subsidies for farmers and the provision of subsidized inputs.

The floods could make it challenging to achieve the aggressive fiscal consolidation budgeted for this year, but it is important to minimize slippages by meeting additional spending needs largely through expenditure re-allocation and foreign grants, while limiting transfers only to the most vulnerable.

Maintaining fiscal discipline is needed to complement monetary tightening, which would together help prevent an entrenchment of inflation and lower external vulnerabilities. 

In line with the slowdown in economic activity, private sector credit continued to moderate, increasing only by Rs86.2 billion during Q1 compared to Rs226.4 billion during the same period last year

This deceleration was mainly due to a significant decline in working capital loans to wholesale and retail trade services as well as to the textile sector in the wake of lower domestic cotton output, and a slowdown in consumer finance.

Headline inflation rose by almost 3½ percentage points in October to 26.6 percent (y/y), driven by a normalization of fuel cost adjustments in electricity tariffs and rising prices of food items. Energy and food prices rose by 35.2 and 35.7 percent (y/y), respectively. Meanwhile, core inflation increased further to 18.2 and 14.9 percent (y/y) in rural and urban areas respectively, as rising food and energy inflation seeped into broader prices, wages and inflation expectations.

The momentum of inflation also picked up sharply, rising by 4.7 percent (m/m). As a result of these developments, inflation projections for FY23 have been revised upwards. While inflation is likely to be more persistent than previously anticipated, it is still expected to fall toward the upper range of the 5-7 percent medium-term target by the end of FY24, supported by prudent macroeconomic policies, orderly Rupee movement, normalizing global commodity prices and beneficial base effects.

The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth.

KARACHI: State Bank of Pakistan (SBP) on Monday kept the benchmark key policy rate unchanged at 15 per cent owing to deceleration in economic activity and contraction in headline inflation.

The SBP said that the Monetary Policy Committee (MPC) decided to maintain the policy rate at 15 per cent. The MPC noted the continued deceleration in economic activity as well as the decline in headline inflation and the current account deficit since the last meeting.

READ MORE: SBP keeps benchmark rate unchanged at 15% amid rising inflation

It also noted that the recent floods have altered the macroeconomic outlook and a fuller assessment of their impact is underway. Based on currently available information, the MPC was of the view that the existing monetary policy stance strikes an appropriate balance between managing inflation and maintaining growth in the wake of the floods.

On the one hand, inflation could be higher and more persistent due to the supply shock to food prices, and it is important to ensure that this additional impetus does not spillover into broader prices in the economy.

READ MORE: Poll sees no policy rate change in August 22, 2022 meeting

On the other, growth prospects have weakened, which should reduce demand-side pressures and suppress underlying inflation. In light of these offsetting considerations, the MPC considered it prudent to leave monetary policy settings unchanged at this stage.

Since the last meeting, the MPC noted several key developments. First, the desired moderation in economic activity has become more visible and entrenched, signaling that the tightening measures implemented over the last year are gaining traction.

With growth likely to slow further in the aftermath of the floods, this tightening will need to be carefully calibrated going forward. Second, 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.

READ MORE: Pakistan hikes key policy rate by 125 basis points to 15%

Third, 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. Fourth, the combined 7th and 8th review under the on-going IMF program was successfully completed on August 29th, releasing a tranche of $1.2 billion.

The MPC discussed the post-flood macroeconomic outlook, noting that projections are still preliminary and would become firmer after the flood damage assessment being conducted by the government is finalized. Based on currently available information, GDP growth could fall to around 2 percent in FY23, compared to the previous forecast of 3-4 percent before the floods.

Meanwhile, higher food prices could raise average headline inflation in FY23 somewhat above the pre-flood projection of 18-20 percent. The impact on the current account deficit is likely to be muted, with pressures from higher food and cotton imports and lower textile exports largely offset by slower domestic demand and lower global commodity prices. As a result, any deterioration in the current account deficit is expected to be contained, still leaving it in the vicinity of the previously forecast 3 percent of GDP.

The economy has slowed considerably since the last MPC meeting. Most demand indicators were lower in both July and August than in the same period last year—including sales of cement, POL, and automobiles. On the supply side, electricity generation declined for the third consecutive month in August, falling by 12.6 percent (y/y).

READ MORE: Dollar jumps to PKR 216.66 amid political crisis

In July, LSM declined by 1.4 percent (y/y), its first contraction in two years, largely driven by broad-based deterioration in domestically-oriented sectors. Looking ahead, the recent floods are likely to adversely affect the output of cotton and rice as well as the livestock sector this year.

The current account deficit shrank for the second consecutive month in August to only $0.7 billion, almost half the level in July. In September, PBS data shows that the trade deficit contracted sharply by 19.7 percent (m/m) and 30.6 percent (y/y) to reach $2.9 billion, reflecting a decline in both energy and non-energy imports amid stable exports. During the first quarter of FY23, imports have declined by 12.7 percent (y/y) to $18.7 billion while exports have grown by 1.8 percent (y/y) to $7 billion. Looking ahead, the floods are likely to result in greater need for some agricultural imports such as cotton and a few perishable food items.

At the same time, exports of rice and textiles are likely to be negatively affected. However, these adverse impacts could to a large extent be offset by downward pressures on the import bill from lower domestic growth and falling global commodity prices and shipping costs. In addition, as experienced after previous natural disasters in Pakistan, the impact on the current account could be further cushioned by international assistance in the form of current transfers. Given secured external financing and additional commitments in the wake of the floods, FX reserves should improve through the course of the year.

In July, fiscal outcomes were better than in the same period last year. The fiscal deficit fell 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. During the first quarter, FBR tax collection rose to Rs 1.625 trillion, surpassing the target by Rs 27 billion.

While the floods could make it challenging to achieve the planned fiscal consolidation this year, the government has so far been able to meet urgent spending needs through re-allocation and re-appropriations of budgeted funds.

Looking ahead, additional foreign inflows, including in the form of grants, should help fund any fiscal slippages. Beyond the current year, reconstruction and rehabilitation will necessitate additional spending over the medium-term, with assistance from the international community.  

In line with slowing economic activity, private sector credit has seen a net retirement of Rs 0.7 billion so far this fiscal year, compared to an expansion of Rs 62.6 billion during the same period last year. This decline in credit mainly reflects a retirement of working capital loans and a sharp fall in consumer finance.

After peaking in August, headline inflation fell by more than 4 percentage points in September to 23.2 percent (y/y), driven by a reduction in electricity prices due to an administrative intervention. At the same time, the momentum of inflation also slowed by more than expected, declining by 1.2 percent (m/m). On the other hand, both core and food inflation picked up further. 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.

Thereafter, it should fall towards the upper range of the 5-7 percent medium-term target by the end of FY24. A continuation of prudent monetary policy and orderly movements in the Rupee should help contain core inflation going forward.

At the same time, curbing food inflation through administrative measures to resolve supply-chain bottlenecks and any necessary imports should be a high priority. The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth.

KARACHI: The central bank of Pakistan on Thursday announced to hike policy rate by 125 basis points to 15 per cent from 13.75 per cent.

The SBP in a statement said that at today’s (July 07, 2022) meeting, the Monetary Policy Committee (MPC) decided to raise the policy rate by 125 basis points to 15 percent.

In addition, as foreshadowed in the last monetary policy statement, the interest rates on EFS and LTFF loans are now being linked to the policy rate to strengthen monetary policy transmission, while continuing to incentivize exports by presently offering a discount of 500 basis points relative to the policy rate.

READ MORE: Pakistan may see further 100bps hike in policy rate

This combined action continues the monetary tightening underway since last September, which is aimed at ensuring a soft landing of the economy amid an exceptionally challenging and uncertain global environment. It should help cool economic activity, prevent a de-anchoring of inflation expectations and provide support to the Rupee in the wake of multi-year high inflation and record imports.

Since the last meeting, the MPC noted three encouraging developments. First, the unsustainable energy subsidy package was reversed and an FY23 budget centered on strong fiscal consolidation was passed. This has paved the way for completion of the on-going review of the IMF program, which will ensure that tail risks associated with meeting Pakistan’s external financing needs are averted.

Second, a $2.3 billion commercial loan from China helped provide support to FX reserves, which had been falling since January due to current account pressures, external debt repayments and paucity of fresh foreign inflows. Third, economic activity remains robust, with the momentum of the last two years of near 6 percent growth carrying into the start of FY23. As a result, Pakistan faces a significantly lower trade-off between growth and inflation than many countries where the post-Covid recovery has not been as vigorous.

READ MORE: SBP increases interest rate by 150bps to 13.75%

However, several adverse developments have overshadowed this positive news. Globally, inflation is at multi-decade highs in most countries and central banks are responding aggressively, leading to depreciation pressure on most emerging market currencies. This strong monetary tightening has occurred despite concerns about a slowdown in global growth and even recession risks, highlighting the primacy that central banks are placing on containing inflation at this juncture. Domestically, as energy subsidies were reversed, both headline and core inflation increased significantly in June, rising to a 14-year high. Inflation expectations of consumers and businesses also rose markedly. At the same time, the current account deficit unexpectedly spiked in May and the trade deficit continued its post-March widening trend to reach a 7-month high in June, on burgeoning energy imports. As a result, FX reserves and the Rupee remained under pressure, further worsening the inflation outlook.

Against this challenging backdrop, the MPC noted the importance of strong, timely and credible policy actions to moderate domestic demand, prevent a compounding of inflationary pressures and reduce risks to external stability. Like most of the world, Pakistan is facing a large negative income shock from high inflation and necessary but difficult increases in utility prices and taxes. Without decisive macroeconomic adjustments, there is a significant risk of substantially worse outcomes that would compromise price stability, financial stability and growth.

READ MORE: SBP may increase key policy rate by 100bps: poll

This could take the form of runaway inflation, FX reserve depletion and the need for sudden and aggressive tightening actions later that would be significantly more disruptive for economic activity and employment. Adjustment is difficult but necessary in Pakistan, as it is all over the world.

However, in the interest of social stability, the burden of this adjustment must be shared equitably across the population, by ensuring that the relatively well-off absorb most of the increase in utility prices and taxes while well-targeted and adequate assistance is provided to the more vulnerable.

Under the MPC’s baseline outlook, headline inflation is likely to remain elevated around current levels for much of FY23 before falling sharply to the 5-7 percent target range by the end of FY24, driven by tight policies, normalization of global commodity prices, and beneficial base effects. While risks exist on both sides, those of significantly higher inflation dominate, prompting today’s rate increase. Going forward, the MPC will remain data-dependent, paying particularly close attention to month-on-month inflation, the evolution of inflation expectations and global commodity prices, as well as developments on the fiscal and external fronts.

READ MORE: Policy rate may rise as T-Bill yields increase sharply

Pakistan’s strong economic rebound from Covid continues, with the level of output surpassing pre-pandemic levels, unlike in many other emerging markets. The needed moderation in economic activity that was occurring through FY22 in response to monetary tightening has stalled in the last three months, fueled by an unwarranted fiscal expansion. Most demand indicators suggest robust growth since the last MPC—sales of cement, POL and automobiles increased month-on-month—and growth in LSM remains high. Looking ahead, growth is expected to moderate to 3-4 percent in FY23, on the back of monetary tightening and fiscal consolidation, helping to close the positive output gap and diminish demand-side pressures on inflation. This will pave the way for higher growth on a more sustainable basis.

After moderating in the previous three months, the current account deficit rose to $1.4 billion in May, on the back of lower exports and remittances partly due to the Eid holiday. Based on PBS data, the trade deficit rose to $4.8 billion in June, more than $1.7 billion higher than its February low. While non-energy imports have continued to moderate in the last three months on the back of curtailment measures by the government and the SBP, this decline has been more than offset by the significant increase in energy imports, which rose from a low of $1.4 billion in February to an estimated record high of $3.7 billion in June. While this partly reflects higher prices, significantly higher volumes of petroleum also played a significant role. Without prompt additional measures to curtail energy imports—for instance through early closure of markets, reduced electricity use by residential and commercial customers, and greater encouragement of work from home and car pooling—containing the trade deficit could become challenging. With such measures, the current account deficit is projected to narrow to around 3 percent of GDP as imports moderate with cooling growth, while exports and remittances remain relatively resilient. The expected completion of the on-going IMF review will catalyze important additional funding from external sources that will ensure that Pakistan’s external financing needs during FY23 are met. Pressures on the Rupee should then attenuate and SBP’s FX reserves should gradually resume their previous upward trajectory during the course of FY23.

READ MORE: State Bank enhances frequency of MP reviews to eight

The fiscal stance in FY22 was unexpectedly expansionary, with the primary deficit estimated at 2.4 percent of GDP, double that of the previous year and more than thrice the budgeted primary deficit of 0.7 percent of GDP. To compensate for this unwarranted fiscal impulse, this year’s budget targets a primary surplus of 0.2 percent of GDP, on the back of significantly higher tax revenue. This consolidation is appropriate given the very rapid economic growth rate of the previous two years and the need to ensure debt sustainability amid high gross financing needs due to the relatively short maturity of Pakistan’s domestic debt. It is critical that the envisaged fiscal consolidation is delivered.

It would allow monetary and fiscal policy to resume the well-coordinated approach that characterized Pakistan’s successful Covid response in FY20 and FY21, which supported growth while preserving fiscal and external buffers. At the same time, it is important that the new taxation measures are progressive. In particular, their burden should mainly be absorbed by the relatively better off while adequate protection is provided to the more vulnerable, for whom high food prices are a particular concern. In this context, curbing food inflation through supply-side measures aimed at boosting output and resolving supply-chain bottlenecks should be high priority.

In nominal terms, private sector credit grew by a further 2 percent (m/m) in May, driven by favorable developments in sectors like power, edible oil, construction-allied industries, as well as wholesale and retail trade. Demand for fixed investment and consumer loans also picked up, reflecting robust economic activity. Since the last MPC meeting, secondary market yields and cut-off rates in the government’s auctions have ticked up in the wake of the high inflation reading in June.

Headline inflation rose significantly from 13.8 percent (y/y) in May to 21.3 percent in June, the highest since 2008. The increase was broad-based—with energy, food and core inflation all rising significantly—and more than 80 percent of the items in the CPI basket experiencing inflation of above 6 percent. Strong domestic demand and second-round effects of supply shocks are reflected in the rise of core inflation to 11.5 percent in urban areas and 13.5 percent in rural areas.

At the same time, measures of both short and long-term inflation expectations continue to tick up. Despite the dampening effect of fiscal and monetary tightening on demand-pull inflation, inflation is likely to remain elevated around current levels for much of FY23 due to the large supply shock associated with the necessary reversal of fuel and electricity subsidies. As a result, inflation during FY23 is forecast at around 18-20 percent before declining sharply during FY24. This baseline outlook is subject to significant uncertainty, with risks arising from the path of global commodity prices, the domestic fiscal policy stance, and the exchange rate.

The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth and will take appropriate action to safeguard them.