Interest rate increased 25bps to 6 percent: SBP raises policy rate for first time in two years

January 27,2018

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KARACHI: The central bank on Friday raised the benchmark interest rate 25 basis points to six percent as it tried to tame inflation stoked by the recent rupee depreciation.

The State Bank of Pakistan (SBP) said in a monetary policy statement said four key factors have witnessed important changes since November 2017, “impinging upon the policy rate decision”.

The policy rate had remained at the 5.75 percent level since May 2016.

“… PKR (rupee) has depreciated by around five percent… oil prices are hovering near $70/barrel… a number of central banks have started to adjust their policy rates upwards adversely affecting PKR interest rate differential vis-à-vis their currencies,” the bank said.

“…multiple indicators show that the output gap has significantly narrowed indicating a buildup of demand pressures.”

Last month, the central bank let the overvalued rupee get equilibrium against the US dollar.

“We have made an exchange rate correction in a one-go to bring stability in the forex market,” Tariq Bajwa, governor of the State Bank told a news conference to announce two-month monetary policy.

SBP said it was the right time to make a policy decision that would balance growth and stability in the medium to long term “in order to preempt overheating of the economy and inflation breaching its target rate”.

The bank said average headline inflation remains within the forecast range of six percent, “but core inflation has continued to rise”.

Average headline inflation for the first half of 2017/18 stands at 3.8 percent, while core inflation (non-food-non-energy) continued to maintain its higher trajectory and clocked in at 5.5 percent during the first six months of the current fiscal year as compared to 4.9 percent a year ago.

“This together with a lagged impact of PKR depreciation and rising international oil prices are likely to increase inflation in the coming months,” the central bank said. “…while the average inflation for FY18 is still projected to fall in the range of 4.5 to 5.5 percent, end of fiscal year YoY (year-on-year) inflation is likely to inch towards the annual target of six percent.”

SBP projected real GDP growth to be around 5.8 percent, significantly higher than 5.3 percent in FY2017, “but marginally lower than the annual target of six percent for FY18”.

“This is largely due to expectations of a below-target wheat crop because of a reduction in area under cultivation,” the central bank said.

The bank sees a gradual reduction in the country’s current account deficit on rupee depreciation, export package, regulatory duties and expected increase in workers’ remittances.

“The high current account deficit could be controlled within the next 4 to 5 years,” Bajwa added.

SBP, however, in the statement said increase international oil prices pose a major risk to the assessment of reduction in current account deficit.

“…managing overall balance of payments in near term depends on the realisation of official financial flows,” it added.

The current account deficit widened to $7.4 billion during the first half of the current fiscal year, up 1.6 times over the corresponding period a year earlier.

The bank said healthy foreign direct investment inflows financed 20 percent of the current account deficit, “and the rest was managed by the official flows and the country’s own resources”.

The SBP’s illiquid foreign exchange reserves witnessed a decline of $2.6 billion since June-end 2017 to reach $13.5 billion as of January 19, 2018.

The central bank said the widening current account deficit and strong growth in imports of goods and services overshadowed the favourable impact of the recovery in exports and rise in remittances.

Export receipts posted the seven-year high growth of 10.8 percent in H1FY2018 against a reduction of 1.4 percent in H1FY2017, while workers’ remittances grew 2.5 percent during the first half over the same period a year earlier.

The central bank expected fiscal deficit for first half of FY2018 to fall close to the last year’s 2.5 percent on growth in revenue collection.

“Higher tax collection and proceeds from the issuance of sukuk and Eurobond have led to reduction in net budgetary borrowing, which stood at Rs401.9 billion during 1 July to 12 January FY18 as compared to Rs470.4 billion in the corresponding period of the previous year,” it added. “Moreover, the delay in sugarcane crushing season also contributed to a modification of demand in private sector credit.”

The central bank said agriculture sector is set to perform better for the second year in a row. Production of all major summer crops, except maize, surpassed the level of FY2017. Similarly, large scale manufacturing (LSM) recorded a healthy growth of 7.2 percent during Jul-Nov FY2018 as compared to 3.2 percent during the same period last year.

“While there could be some deceleration in LSM growth due to sector specific issues such as sugar, POL (petroleum, oil and lubricants) and fertiliser, overall industrial activity is likely to remain strong,” the bank added.

“Benefiting from both infrastructure and CPEC (China-Pakistan Economic Corridor) related investments, construction and its allied industries are expected to maintain their higher growth momentum.”


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