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July 17, 2019

Policy rate raised by 100 basis points to 13.25pc: Inflation higher than previously projected, says SBP

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July 17, 2019

KARACHI: The State Bank of Pakistan (SBP) on Tuesday raised its policy rate by 100 basis points to 13.25 percent — a seventh straight hike — pushing the rate to an eight year high as it tries to quell inflation pressures and rupee depreciation in an underperforming economy.

SBP Governor Reza Baqir said the decision, broadly in line with the market expectations, took into account upside inflationary pressures from exchange rate depreciation and the likely increase in near-term inflation from the one-off impact of recent adjustments in utility prices and other measures in the FY2020 budget.

The SBP projected an average inflation in the range of 11 to 12 percent during the current fiscal year of 2019/20, higher than previously projected. Inflation rose considerably to 7.3 percent in FY2019 due to higher government borrowing from SBP, lagged impact of exchange rate depreciations, hike in domestic fuel prices, and rising food prices.

"Our inflation projections are consistent with the medium-term inflation target," Baqir said at a news conference. The central bank raised its policy rate by a cumulative 750 basis points since January 2018 to contain demand and address external account pressures.

Governor Baqir said adjustments in utility prices and other measures in the budget are expected to lead to a one-time considerable increase in prices in the first half of FY2020. The central bank, however, expected inflation to fall considerably in FY2021 "as the one-off effect of some of the causes of the recent rise in inflation diminishes".

"The government has also committed to cease borrowing from the State Bank that would qualitatively improve the inflation outlook," it said in a statement on the monetary policy for the next two months.

Baqir said tight monetary policy would support the exchange rate and lead to decline in the dollarisation of the economy "as people will have a preference to keep savings in rupee instead of dollars".

The governor said the interest rate increase would benefit savers. "People who have poured money into national savings schemes and fixed income deposits in banks will get higher returns on these instruments due to hike in interest rates."

The SBP governor said the currency is volatile at the initial level in a flexible market-determined exchange rate, "but thevolatility eased with the passage of time that is normal in the emerging markets." "The overvaluation in the exchange rate has been completed," he added. "The pressure in the foreign exchange market was due to higher current account deficit."

Economist Bilal Khan at the Standard Chartered Bank agreed that the market was expecting a more front-loaded increase in interest rates, "marking a decisive pause in the current rate hiking cycle".

"In addition to flagging the macro (economic) outlook, SBP’s policy statement appears intended to calm foreign exchange and rate market sentiment." The SBP estimated domestic demand to moderate to about 3 percent in FY2019 and GDP growth to 3.3 percent, while it expected the real GDP growth of around 3.5 percent in FY2020.

"While current high frequency indicators point to a slowing in economic activity, this is expected to turn around in the course of the year on the back of improved market sentiments in the context of IMF- (International Monetary Fund) supported program, a rebound in the agriculture sector and the gradual impact of government incentives for export-oriented industries," it said. Pakistan and IMF this month reached a three year $6 billion loan programme.

Baqir sees a positive outlook for the externals sector, saying the non-oil current account deficit is almost zero. The SBP said the outlook for external financing has further strengthened with the disbursement of the first tranche associated with the IMF's extended fund facility, activation of the Saudi oil facility, and other commitments of support from multilateral and bilateral partners. The SBP's foreign exchange reserves rose to about $8 billion on 12 July 2019 with the disbursement of the first tranche of the IMF's extended fund facility.

"Reserves are expected to rise further in FY20 on account of additional financial inflows from other international creditors, including those related to the Saudi oil facility and continued improvement in current account deficit."

The SBP said the fiscal consolidation would support the central bank's stabilisation policies. "The FY20 budget seeks to credibly reverse the recent trend of fiscal deterioration by addressing long-standing weaknesses in the taxation system and to enhance documentation of economic activities," it added. "On the back of an ambitious target for tax collection and tight control over expenditures, the budget envisaged a sizable reduction in primary deficit."

Both the overall fiscal and primary deficits deteriorated in FY2019, led by substantial shortfall in revenue collection, higher than budgeted interest payments and security related expenditures.

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