SBP keeps interest rate unchanged at 7 percent to support ‘nascent recovery’

KARACHI: The State Bank of Pakistan (SBP) on Friday left the policy rate unchanged at 7 percent to act appropriately as there are upside risks to current growth projection although inflation expectations remain well-anchored.

“Since the last meeting in November the domestic recovery has gained some further traction… there are upside risks to the current growth projection of slightly above 2 percent in FY21,” the SBP said in a statement. “On the inflation front, recent out-turns are also encouraging, suggesting a waning of supply-side price pressures from food and still-benign core inflation.”

The SBP expects inflation to fall within the previously announced range of 7-9 percent for FY21. “The existing accommodative stance of monetary policy remained appropriate to support the nascent recovery while keeping inflation expectations well-anchored and maintaining financial stability,” it said.

SBP Governor Reza Baqir said the inflationary pressure is due to increase in utility prices and spike in international oil prices. “But this phenomenon is temporary,” Baqir told a news conference.

“Any change in the policy in future will be gradual,” he said. SBP governor dispelled the impressions that the policy stance is a prologue to restoration of International Monetary Fund’s program.

“There are misconceptions among businessmen and markets that going to the IMF program means sudden reversal in the monetary policy stance,” he said.

“Now the current account is in surplus due to the implementation of the market-based exchange rate regime. The increase in the central bank’s foreign exchange reserves to $13 billion from $7 billion is not because of foreign loans.”

For the first time, the SBP provided forward guidance as it expected inflation to trend toward the 5-7 percent target range over the medium-term.

“The forward guidance tool will help give us confidence, avoid surprises, ensure economic stability and ease uncertainty in the markets and the business community in future,” said Baqir.

The monetary stance is in line with the market expectations after the SBP delivered a cumulative reduction of 625 basis points five times during the last year to buoy sinking growth amid coronavirus lockdown. The economy contracted 0.4 percent during the last fiscal year of 2019/20.

The State Bank sees ‘considerable uncertainty’ around the outlook due to COVID-19. "In the absence of unforeseen developments, the MPC [Monetary Policy Committee] expects monetary policy settings to remain unchanged in the near term,” said the SBP. “As the recovery becomes more durable and the economy returns to full capacity, the MPC expects any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates.”

The SBP said the economic recovery underway since July has strengthened in recent months. Large-scale manufacturing (LSM) grew 7.4 percent year-on-year in October and 14.5 percent in November. The manufacturing recovery is also becoming more broad-based, with 12 out of 15 subsectors registering positive growth in November and employment beginning to recover. So far this fiscal year, LSM has grown by 7.4 percent against a contraction of 5.3 percent during the same period last year. The SBP said the trade deficit rose due to a rise in imports of machinery and industrial raw material, in line with the pick-up in economic activity, while remittances and exports continued to grow steadily. The current account remained in surplus during the first half of FY21, at $1.1 billion compared to a deficit of over $2 billion during the same period last year, mainly driven by workers’ remittances.

The current account deficit for FY21 is projected to remain below 1 percent of GDP. The SBP said fiscal developments have been largely in line with this year’s budget and the government has continued to adhere to its commitment of no fresh borrowing from the SBP.

The SBP said financial conditions remain appropriately accommodative at this early stage of the recovery, with the real policy rate in slightly negative territory on a forward-looking basis.

“As demand recovers and inventories fall in some sectors, working capital loans have also picked up for the first time since the onset of the COVID pandemic, although their level remains lower than last year,” said the SBP.