ISLAMABAD: Highlighting four major challenges being faced by the country’s economy including persistence surge in twin deficits, the State Bank of Pakistan (SBP) on Thursday slightly hiked the discount rate by 25 basis points to 10.25 percent in a bid to further suppress the demand for stabilising the economy.
The Monetary Policy Committee (MPC) took the decision of hiking the discount rate by 25 basis points with majority. Some members of the MPC were in favour of keeping the discount rate unchanged at 10 percent but with majority, the discount rate hiked to 10.25 percent. The SBP had hiked the discount rate by 450 basis points in the last 12 months starting from 5.75 percent to now 10.25 percent.
“Keeping in view challenges on economic front, the MPC after detailed deliberations decided to raise the policy rate by 25 bps to 10.25 percent effective Feb 1, 2019,” said SBP Governor Tariq Bajwa as he unveiled the MPC decision in a news conference here at the SBP building on Thursday.
Flanked by SBP officials and MPC member Dr Alyia Hashmi, the SBP Governor said that the MPC noted that the impact of stabilisation measures implemented so far was gradually unfolding and confidence was improving amidst reduced economic uncertainty, but (i) the fiscal deficit is yet to show signs of consolidation despite a reduction in PSDP spending; (ii) although a gradual improvement in current account deficit is visible, it remains high; (iii) a marked shift in the pattern of government borrowing from scheduled banks to SBP entails inflationary concerns; and (iv) even as stabilisation measures graduallywork through the economy, underlying inflationary pressures persist. Based on the above and after detailed deliberations, the MPC decided to raise the policy rate by 25 bps to 10.25 percent, he added.
When asked whether the banks were dictating the hike in discount rate knowingly as the government seemed a desperate borrower, the governor replied that there was an impressive response in the last auction of PIBs indicating that the banks were ready to provide funding to the government. It is a wrong impression that the banks are dictating on discount rates, he added.
To another query about oil facility on deferred payments, he said that Pakistan and Saudi Arabia struck deal on oil facility and it would be announced on the occasion of Saudi crown prince’s visit to Pakistan on February 16, 2019. “The external inflows which remained lower in the first half, were expected to be increased in second half of the current fiscal year,” he added. He also said that the recent increase in discount will result into slight hike in debt servicing obligations.
In absolute terms, he said that net budgetary finance from the SBP reached Rs3,770.5 billion during 1st Jul-18th Jan FY19, which is 4.3 times the amount borrowed during the same period last year. This financing will potentially have inflationary consequences in future.
A major chunk of this borrowing was used to retire government debt from commercial banks (a net retirement of Rs3,035.8 billion). This huge shift in government borrowing from commercial banks to SBP has incentivised private sector lending. The banks seem keen to redeploy their funds as there is hardly any increase in spreads charged by banks during the current cycle of monetary tightening and economic slowdown. Both the healthy credit off-take and higher government borrowing were the primary contributors to higher broad money (M2) growth of 2.2 percent during 1st Jul-18th Jan FY19 as compared to 1.1 percent during the same period last year.
The fiscal deficit for the first half FY19, he said, is likely to be higher than the same period last year. This shows that despite a sharp cut in PSDP releases and rationalisation of tariffs and duties, fiscal consolidation remains a challenge. The MPC reiterated its earlier view that fiscal policy will have to be proactive and play a supportive role in generating conditions for stability and sustainable growth.
On external front, he said the current account deficit (CAD) recorded a YoY reduction of 4.4 percent during the first half of the year to $8.0 billion. This improvement is largely driven by a sharp deceleration in import of goods and services.
The impact of stabilisation measures is amply visible from non-oil imports, which saw a contraction of 4.4 percent during the first half of FY19 against an increase of 19.1 percent during the same period last year. A marginal increase in exports and a healthy growth in remittances also helped contain the current account deficit.
“The financing of CAD, nevertheless, remained challenging as the private (Foreign Direct Investments and private loans) and official inflows were insufficient to completely finance the deficit,” he said and added that thus, a significant part of CAD was managed by using the country’s own resources, which reduced the SBP’s net liquid foreign exchange reserves to $7.2 billion by end-December 2018. However, the realisation of bilateral official flows in the last a few days has helped increase SBP’s net liquid foreign exchange reserves to $8.2 billion and the country’s FX reserves to $14.8 billion as of 25th January 2019.
He said that economic data released after the last MPC meeting in November 2018 confirms that the stabilisation measures implemented during the last 12 months are taking hold. Key monthly indicators are showing visible signs of deceleration in domestic demand.
The current account deficit is narrowing down, albeit gradually. This, along with an increase in financial inflows, is contributing to reduced pressures on the country’s external accounts. These developments are encouraging and have served to reduce some economic uncertainty. However, challenges to Pakistan’s economy persist: (a) despite narrowing down the current account, deficit remains high; (b) fiscal deficit is elevated; and (c) core inflation is persistently high. This situation calls for continued consolidation efforts.
The average headline CPI inflation, he said, stands at 6.0 percent for the first half of FY19, which is considerably higher than the 3.8 percent recorded during the same period last year.
Meanwhile, headline year on year (YoY) inflation has shown some moderation during the last two months, primarily due to a sharp fall in prices of perishable food items and a downward adjustment in prices of petroleum products. The impact of these developments has also been captured in the recent IBA-SBP’s consumer confidence survey, which indicates some moderation in households’ inflation expectations. Despite these positives, core inflation as measured by non-food-non-energy components of the CPI basket has reached 8.4 percent in December 2018.
Going forward, he stated the second round impacts of the exchange rate movements, upward adjustments in gas and electricity tariffs, and higher government borrowings from SBP are likely to be offset by the lagged impact of the increase in policy rates and the fall in international oil prices, on inflation. Accordingly, the projected range of inflation remains unchanged at 6.5 to 7.5 percent.
He said the pickup in inflation and the continuation of economic challenges are taking their toll on economic performance. Real economic activity has witnessed a marked slowdown during the first half of the year. Large scale manufacturing, which has strong backward and forward linkages, saw a net contraction of 0.9 percent during the first five months of this fiscal year, mainly due to a moderation in domestic demand and some sector specific challenges.
Meanwhile, all major kharif crops have recorded a decline in production from last year’s levels. The initial assessment of the wheat crop is also not encouraging. Both, the direct and the knock on, impacts of changes in commodity producing sectors on the services sector, is likely to reduce real GDP growth for FY19 to around 4.0 percent, well below both the annual target of 6.2 percent and the 5.8 percent growth realised in the previous year.
Credit to private sector (CPS), he stated, saw a net expansion of Rs570.4 billion during July-Dec FY19, which was almost double the level of expansion during the same period last year. This growth is largely attributed to higher cost of raw materials (cotton, petroleum products, etc), continuation of capacity expansion in power and construction-allied industries (especially cement and steel), and favorable liquidity conditions due to retirement of government borrowing from commercial banks, he concluded.
