SBP holds interest rate at 22pc, cites improved inflation, rupee outlook

KARACHI: The State Bank of Pakistan unexpectedly left its benchmark interest rate steady at 22 percent on Thursday as it does not see any indications of an overheating economy or rising inflation pressures.

This decision to keep rates unchanged comes as inflation in Pakistan slowed to 27.4 percent in August from its peak of 38 percent in May. Inflation for the month of July was 28.3 percent.

Analysts and the markets had expected the SBP to raise the policy rate by 100–200 basis points in an effort to rein in inflation and stabilise the rupee. Instead, the SBP surprised everyone. The Monetary Policy Committee (MPC) of the SBP is confident that despite rising energy and oil prices, inflation will remain in check. The SBP is also positive about the regulatory and law-enforcement steps being made to stop currency smuggling and speculation. The SBP is optimistic about the fiscal year’s improved agricultural prospects.

“Inflation is projected to remain on the downward trajectory, especially from the second half of this year,” the SBP said in a monetary policy statement.

“As such, real interest rates continue to remain in positive territory on a forward-looking basis. Moreover, the expected ease in supply constraints owing to better agriculture output and the recent administrative measures against speculative activity in the FX and commodity markets would also support the inflation outlook,” it added.

“The MPC also noted that inflation is likely to increase significantly in September mainly due to the base effect and the adjustment in energy prices. It is expected that inflation will subsequently decline in October and maintain its downward trajectory from thereon,” it said.

A substantial risk exists, according to analysts that inflation would continue to be higher than the SBP projection due to rising global oil prices and changes in Pakistan’s energy prices. Thus, they forecast that FY2024’s average inflation will be 23 percent; in July, SBP estimated that FY2024’s average inflation would be in the 20–22 percent range.

There is a need to know the IMF’s opinion on inflation and the general SBP stance on tightening as the IMF’s review of the country’s lending facility is most likely to take place in October or November. If the IMF is not pleased with the overall targets, rates may be adjusted at the subsequent MPC meeting, according to analysts.

In the wake of a crucial $3 billion IMF loan programme that was approved in July, the crisis-ridden country is attempting to chart a road to the economic recovery while struggling with growing inflation and diminishing foreign exchange reserves.

The SBP left the policy rate unchanged at its recent meeting in July. It has hiked interest rates by a cumulative 15 percentage points to 22 percent since September 2021.

“The decision is in line with our expectations. I think it’s a fair decision, given that there are no signs of an overheating economy, and a rate hike would have yielded little benefit in terms of curbing cost-push inflation,” said Fahad Rauf, the head of research at Ismail Iqbal Securities.

“Moreover, rate hikes would have further increased government fiscal deficit, and created a credit risk for the banking system,” Rauf added.

During an analyst briefing, central bank governor Jameel Ahmed said in FY2024, Pakistan is scheduled to repay a total of $24.6 billion, which includes $3.4 billion in interest payments and slightly over $21 billion in principal repayments.

So far this fiscal year, an amount of $2.8 billion has been successfully returned, consisting of $2.2 billion in principal and the remaining $0.6 billion in interest. This leaves an outstanding balance of $19 billion yet to be settled, said Arif Habib Limited, citing the SBP’s governor.

Approximately $11 billion of this amount is anticipated to be rolled over, with $8 billion already confirmed for rollover and the remaining $3 billion in rollover commitments in the pipeline. Consequently, the net repayable amount stands at $8 billion.

During the recent T-bill auction, where cut-off rates surpassed the policy rate of 22 percent, the SBP attributed this development to a backdrop of economic uncertainty, the rupee devaluation, and market expectations of a potential policy rate hike. However, subsequent efforts by authorities to stabilize the currency led to a turnaround in its value. The SBP emphasised the significance of weighted average rates, noting that the 3-month papers’ weighted average rate was around 23.4 percent, which remained below the cut-off rate.

In a recent update on foreign currency dealers, the SBP governor has informed that there are presently 121 franchises operating under franchise agreements with foreign exchange companies of which 19 fall under Category B companies.

“In not raising the policy rate we are happy to see the MPC recognise that supply-led inflation is best cured by nature as in agriculture or by easing the obstacles to supplies, such as import constraints. Therefore policy rate is not an appropriate measure,” said the Pakistan Business Council on the social media platform X, formerly known as Twitter.

“Secondly that demand pull inflation is already contained by rising fuel and tariff rates. Lastly, the exchange rate is a function of public perception and confidence in the economy as well as demand for dollars by smugglers and uderinvoicers, best curbed through tighter border controls and valuation checks rather than policy rate.”