SBP may hold rates steady as inflation peaks, economy contracts

KARACHI: The State Bank of Pakistan (SBP) is expected to leave benchnark interest rate unchanged at its policy meeting on Monday, June 12, as inflationary pressures may subside in the coming months, analysts said.

There will be a lot of mystery surrounding what the SBP Monetary Policy Committee (MPC) is going to do with interest rates, as the rate-setting decision will be announced after the national budget is scheduled to be unveiled on June 9 by a government facing historic economic challenges. Investors will focus on the central bank's forecast for consumer price inflation, which hit another record high in May, making it Asia's fastest for a second month, the risks it sees to the country's economy due to the stalled International Monetary Fund (IMF) lending programme, which will end this month, and growing concerns about sovereign default.

Since the latest monetary policy meeting of the central bank on April 4, the economy has been contracting. The output of large-scale manufacturing fell by 25 percent in March. Despite the fact that consumer price index (CPI) inflation rose 37.97 percent in May from a year earlier, price pressures are expected to begin decreasing in the coming months, which will cool calls for rate hikes. Inflation is projected to be in the range of 30 percent to 31 percent in June. "GDP growth was only 0. percent, and that too is being alleged of being manipulated," said Fahad Rauf, the head of research at Ismail Iqbal Securities.

"Inflation will recede from June onwards as international commodity prices have dropped, while there is also a high base effect. Moreover, globally, the tightening cycle seems to have stopped," Rauf added. "Considering these factors, the SBP might keep rates unchanged in the June policy." The SBP raised its benchmark interest rate by 100 basis points to 21 percent in April. The SBP raised the policy rate by 1.125 percentage points since November 2021 because it thought the inflation rise was widespread, even though a significant portion of it came from the food and energy components. This represented the passing through of tax and duty hikes, the winding down of energy subsidies that weren't targeted, and the depreciation of the exchange rate.

The head of research at Taurus Securities, Mustafa Mustansir, predicts that the policy rate won't change after the budget. "For now our house base case expectation is that we see no further change in rates until March 2024. But inflation will remain high. For instance, our expectation for June is about 31 percent plus for next fiscal year we see inflation clocking in at 21 percent, despite the high base effect. The SBP projects the average inflation this fiscal year to be in the range of 27 percent to 29 percent. The financial market participants polled by Topline Research see a slim chance (23 percent) of a rate increase in the upcoming policy meeting, with the majority (69 percent) expecting a status quo.

"We anticipate monthly CPI inflation to soften from June 2023 and gradually decline over the next 12 months majorly because of base effect along with tight monetary and fiscal policy," said an analyst at Topline Securities.

"Petrol and diesel prices are also down by 7-12 percent last month. This will also ease inflation in the coming months unless there is any major pressure on the rupee. We also expect no change in the upcoming MPC meeting," he added. Ehsan Malik, the CEO of The Pakistan Business Council (PBC), believes interest rate is not the right tool for all types of inflation. "High-interest rate does not bring down the price of short-supplied food items. Nor does it improve the supply of import-crunched goods," Malik said.

There are demand compression measures already in place, such as SBP lending restrictions on auto financing, he added. Secondly, high interest rates hurt the formal economy, not the underground economy which is growing at a faster rate with smugglers filling the gaps left by import-crunched formal industry, according to Malik.

"In many ways, this is a perfect storm for the formal sector. Not only does it suffer from unabsorbed fixed costs due to underutilisation of capacity, it has to borrow more or retain past profits to meet working capital needs," he said. "The banks are reluctant to take risks to lend further to the private sector as they also have less risky options to lend to the government. Even if they lend to the private sector, it is at a higher rate due to increase in the policy rate."