SBP raises interest rate by 100bps to 8.5pc to ensure stability

KARACHI: The central bank on Saturday raised interest rate by 100 basis points to 8.5 percent – a move that was widely expected – to stabilise the economy imperiled by large twin deficits and rising inflation.

“… further consolidation efforts are required to ensure macroeconomic stability and therefore (the monetary policy committee) has decided to raise the SBP target policy rate by 100 bps to 8.5 percent effective from 1 October 2018,” the State Bank of Pakistan (SBP) said in a monetary policy statement for the next two months.

The committee vocally attributed three reasons behind this year’s fourth increase in the benchmark interest rates, while presenting the first monetary policy in the new Pakistan Tehreek-e-Insaf-led regime.

The interest rate has cumulatively been increased by 175 basis points since January.

“While non-oil imports are responding to the contractionary measures a surge in oil prices is masking this improvement, and as a result the current account deficit remains high,” the SBP said. Secondly, rising trends in inflation mean that real interest rates have fallen, while unfolding global developments, including oil-price shocks, protectionist trade policies and/or falling flows to the emerging markets, “all pose challenges to macroeconomic management”. Topline Securities said the rate hike is likely to partially help in containing demand and import growth.

“But, more measures need to be taken on the fiscal side to control external account issues,” the brokerage said in a flash note.

The SBP said the country witnessed notable changes on the political front and this has had a positive impact on the business and consumer confidence in the country as reflected in multiple surveys.

“The smooth transition between governments addresses the political uncertainty observed hitherto, but concerns on the economic front continue to persist on the back of rising inflation and large twin deficits, that are likely to compromise the sustainability of the high real economic growth path.”

The SBP said inflation is inching up, particularly from March onwards. Headline consumer price inflation averaged 5.8 percent in the first two months of FY2019, as compared to 3.2 percent for the corresponding months of FY2018, and an average of 3.9 percent for FY2018. “The jump is even more pronounced in core inflation – a key measure reflecting the underlying inflationary pressures in the economy,” it added. “… the average headline inflation is expected to fall in the revised forecast range of 6.5-7.5 percent. … (due to) … a higher than anticipated increase in international oil prices, an upward revision in domestic gas prices, a further increase in regulatory duties on imports and the continuing second round impact of previous exchange rate depreciations.”

The State Bank projected real GDP growth to decelerate to five percent in the current fiscal year of 2018/19 compared to 5.8 percent in FY2018 and much below the government’s ambitious target of 6.2 percent “as the general macroeconomic policy mix is focusing towards stabilisation”.

“The government is also now pursuing a fiscal consolidation program and has further announced regulatory measures to slowdown the growing pressures on the external front,” it said.

The SBP said the recent monetary and fiscal measures are likely to affect large scale manufacturing. Cotton production is expected to miss its FY2019 target of 14.4 million bales with downside implications for agriculture sector growth. The ancillary services sector is expected to miss its annual target as well.

The SBP said some positive impact is, however, expected from the contribution of exports-led production and higher fertiliser production amidst depleting stocks and better availability of energy.

The State Bank said current account deficit continues to pose a challenge. A notable increase in the value of oil imports kept the current account deficit at $2.7 billion in the first two months of the current fiscal year despite some growth in workers’ remittances and exports, as compared to $2.5 billion in the corresponding period last year.

“Owing to these developments SBP’s net liquid FX (foreign exchange) reserves have declined to $9 billion as of 19th September, 2018 compared to $9.8 billion at the end of FY18.”

The SBP expected private sector’s credit off-take to slow down in FY2019 compared to FY2018 despite its relatively better performance during 1 July to 14th September.

Private sector credit continues to grow due to “the improved availability of energy, relatively conducive exports demand amid GSP (generalised scheme of preferences) plus status and the higher working capital needs due to capacity additions in the last three years,” it said.