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July 18, 2019

High interest


July 18, 2019

If there was any expectation that the State Bank of Pakistan (SBP) would keep the policy rate stable, it has been quickly put aside after the central bank announced another increase of 100 basis points. The seventh straight hike in policy rate puts the base interest rate at 13.25 percent. The central bank has done little to ally fears over an economy in severe distress. It was hoped that after the confirmation of the IMF deal, the SBP would move to stabilize interest rates. This has not happened as interest rates have hit an eight-year high. According to the SBP, the decision is aimed at controlling inflation and rupee depreciation. The trouble is that this is a strategy that is not working. The SBP itself has admitted that inflationary pressures are higher than its expectations. In itself, the SBP governor has claimed that the hike inflation is due to the impact on one-off adjustments in utility prices and other budget measures, but there is no promise of either utility prices remaining stable, or there being no further depreciation of the rupee. Either of these is likely to push inflation further, which might lead the SBP to keep playing the game of cat-and-mouse to meet inflation midway.

The real question to ask is whether the existing set of policies are working. It would appear there is little reflection on this at the helm of the SBP. Each decision to hike the policy rate is accompanied with the same set of explanations. The inflation projection for 2019/20 has now been revised to be between 11 and 12 percent, which is higher than previously projected. This should either raise questions about earlier projections, or about whether the current ones are still underplaying the real impact of the government’s policies. The ‘lagged’ impact of exchange rate depreciation is yet to have been fully felt in the economy, which is likely to play a significant role in pushing inflation higher.

The SBP says that the government has committed to stop borrowing from the bank, but this does not fall in line with the government’s budget deficit projections for the current fiscal year. The SBP chairman also made a contentious observation in claiming that the high interest rates would encourage rupee savings, instead of dollar savings. This could be true if inflation were not so high and the rupee not expected to be devalued further. In reality, putting a positive spin on the hike in interest rates is not an easy task. As it stands, the government and SBP’s policies are not pointing in an optimistic direction.

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