State Bank keeps interest rate unchanged at 7pc on inflation uptick

KARACHI: The central bank on Monday decided to keep the interest rate unchanged at 7 percent, very much in line with the market expectation, as the lockdown-hit economy is showing a sign of recovery with inflation crossing above the initial forecast.

The State Bank of Pakistan (SBP) said business confidence and the outlook for growth have improved compared to the time of the last meeting of monetary policy committee in June due to easing of lockdowns and timely stimulus by the government and the SBP.

SBP Governor Reza Baqir said inflation has increased due to increase in the food prices and supply side shocks. “The rise in inflation was not driven by demand,” Baqir said.

The SBP said the forecast for inflation has risen slightly, primarily due to recent supply side shocks to food prices. “Average inflation is now expected to fall within the previously announced range of 7 to 9 percent during FY2021, rather than marginally below,” it said in a statement.

SBP governor said the economy is gradually recovering. “So, it’s necessary to maintain stability as well as to maintain the interest rates at the current levels.” Baqir said coronavirus infection cases were increasing in June when the last monetary policy was announced.

“There was also a lot of economic uncertainty worldwide. Now, most of our economic indicators are improving,” he said. “Exports and remittances are picking up. Sales of auto sales, cement and petroleum products are increasing.”

The SBP reduced interest rates by 625 basis points to 7 percent between March and June to support economic growth in response to COVID-19 challenges. The announcement was deferred till September.

“Through, these measures we addressed liquidity constraints and prevented companies from reaching the insolvency stage,” Baqir said. In July-August, annual consumer inflation was recorded at 8.74 percent, according to the official data.

“The stance of monetary policy remained appropriate to provide needed support to the emerging recovery, while keeping inflation expectations well-anchored and maintaining financial stability,” the SBP said.

The State Bank said notwithstanding an uptick in headline inflation during June and July, core inflation has been relatively stable and demand-side risks to inflation remain well-contained.

The SBP said the inflation outlook is also subject to certain risks. “On the upside, risks revolve around food prices, especially in the wake of recent flood-related damages and potential locust attacks,” it said. “On the downside, the main risk stems from a lower-than-expected pickup in domestic activity.”

The State Bank said the future trajectory of oil prices will also have an important bearing on the domestic inflation outlook. The State Bank said growth is projected to recover to slightly above 2 percent in FY2021, after falling to negative 0.4 percent last fiscal year of 2019/20.

“The recovery is expected to be driven mainly by manufacturing-related activities and construction, which are being supported by various financial policies and the government’s incentives for the housing and construction sectors,” it said.

However, the growth outlook is subject to uncertainty, the SBP said. “On the downside, risks include a potential second wave of Covid-19 domestic infections, a possible sharp increase in infections in the winter months in Pakistan’s major export markets in Europe and the US, and the threat to agriculture from locust attacks,” it said. “On the upside, a faster global recovery could lift exports higher.”

The State Bank said the current account deficit is expected to remain bounded at around 2 percent of GDP. “This, together with expected private and official flows, should continue to keep Pakistan’s external position stable in FY2021.”

The SBP said the external sector has remained resilient since the coronavirus outbreak. The flexible market-determined exchange rate, introduced in May last year, has played its valuable role as a shock absorber, as witnessed in orderly two-way movement of the currency. “The increase in the foreign exchange reserves was not due to foreign loans and portfolio investment. It was because of quality reserves,” said Baqir.

SBP governor said the government is engaged with the IMF at technical level discussions. “We have to see when the economy is going to stabilise.” The State Bank expected the pre-pandemic path of fiscal consolidation to resume as economic activity recovers in coming quarters.

“Despite severe pressures from the coronavirus and contrary to expectations, the fiscal deficit for FY2020 ended lower than in FY2019 and the increase in public debt was contained to around 1 percent of GDP,” said the SBP. “This largely reflects the strong steps taken by the government to ensure a primary surplus in the first nine months of FY2020, which helped provide fiscal space to respond to the coronavirus outbreak.”

In July-August, tax revenues returned to positive growth, averaging around 1.2 percent year-on-year. “While far below pre-pandemic growth rates, this recovery in tax collections represents an encouraging turnaround from the double-digit reduction observed during the last quarter of FY2020, although risks remain around achieving the revenue target,” said the SBP.