Wednesday December 06, 2023

SBP maintains interest rate at 21%

SBP says inflation has peaked at 38% in May 2023 and it expects it to start falling from June onwards

June 12, 2023
An undated image of the State Bank of Pakistan building in Karachi. — AFP
An undated image of the State Bank of Pakistan building in Karachi. — AFP

The State Bank of Pakistan's (SBP) Monetary Policy Committee (MPC) decided against increasing the interest rate as it "views inflation to have peaked at 38% in May 2023, and barring any unforeseen developments, expects it to start falling from June onwards".

The MPC had met in April last in which it had jacked up the key policy rate by 100 basis points to a record high of 21% to control inflation.

Since January 2022, the SBP had raised rates by a total of 1,150bps.

The statement by the central bank today stated that "higher inflation outturns for April and May were broadly as anticipated". It also "noted a sequential ease in inflation expectations of both consumers and businesses from their recent peaks".

The committee also expects "domestic demand to remain subdued amid tight monetary stance, domestic uncertainty and continuing stress on external account".

"In this backdrop, and given the declining m/m trend, the MPC views inflation to have peaked at 38% in May 2023, and barring any unforeseen developments, expects it to start falling from June onwards," the statement further said.

On inflation, the SBP also said that it "remained broad-based" owing to the increase in food prices.

"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," said the SBP. However. central bank "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".

"In this context, the MPC views that maintaining the current policy stance is necessary to bring inflation down to the medium-term target range of 5%–7% by the end of FY25," it noted.

The central bank also added that "broad money growth decelerated in May 2023 compared to last year, largely due to a substantial fall in private sector credit (PSC) and a contraction in net foreign assets of the banking system".

Budget 'envisages slightly contractionary fiscal stance'

The MPC also took stock of the "multiple important developments" that took place since it had last met.

Amon those it noted that the provisional National Accounts estimates showed a deceleration in the "real GDP growth" in the ongoing fiscal year. Secondly, it shared that the current account balance recorded back-to-back surpluses in March and April 2023, which had "reduced some pressures on foreign exchange reserves".

"Third, the government unveiled the budget for FY24 on June 9, which envisages a slightly contractionary fiscal stance against the revised estimates for FY23. Fourth, the global commodity prices and financial conditions have eased recently and are expected to persist in near term," said the statement.

The MPC also noted that the impact of the "substantial monetary tightening" is "still unfolding".

"On balance, the MPC views the current monetary policy stance, with positive real interest rates on a 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. However, the MPC emphasised that this outlook is also contingent on effectively addressing the prevailing domestic uncertainty and external vulnerabilities," the central bank said.

External and fiscal sectors

On the external sector, the SBP stated that the current account has been responding to the "demand-compression policies and regulatory mix" as the deficit during Jul-Apr FY23 dropped to $3.3 billion — less than one-fourth of last year’s deficit.

"The policy-induced contraction in imports more than offset the drop in exports and remittances. The committee noted that the narrowing of the current account deficit has somewhat contained pressures on the foreign exchange reserves and the interbank exchange rate, which has broadly remained stable since the last MPC meeting," the statement further said. But it warned that the "debt repayments amid lower fresh disbursements and weak investment inflows" are exerting "pressure" on the forex reserves.

However, the committee was optimistic about the current account deficit will remain "in check" due to the "baseline assumptions of the relatively favourable outlook for commodity prices and moderate domestic economic recovery next year".

On the fiscal side, the central bank noted that the position had "improved" during Jul-Mar FY23, as the fiscal deficit reduced slightly to 3.6% of GDP from 3.9% last year, while the primary balance posted a surplus of 0.6% of GDP this year 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. Usual end-year increase in developmental spending and further slowdown in revenue collection amidst substantial slowdown in domestic economic activity and contraction in imports, points to a further increase in the fiscal deficit in Q4," said the central bank.

As per the "revised estimates" the fiscal deficit would remain at 7.0% and the primary deficit at 0.5% of GDP for FY23.

Meanwhile, the budget presented by Finance Minister Ishaq Dar has projected a fiscal deficit at 6.5% and a primary surplus of 0.4% of GDP.

On the budget projections, The MPC noted that the target was "not significantly different from the revised estimate for FY23". However, it advised to "strictly" adhere to it as it is "imperative to contain inflationary and external account pressures".