State Bank leaves interest rate unchanged at 7 percent

KARACHI: The central bank held the benchmark interest rate steady fifth time on Friday, citing a rapid economic recovery from the COVID-19-led downturn and expectation that the economy would grow faster than previously thought due to fiscal measures and monetary stimulus.

"The monetary policy committee (MPC) decided to maintain the policy rate at 7 percent," the State Bank of Pakistan (SBP) said in a statement.

However, it said accommodative stance of monetary policy remains appropriate to ensure the recovery becomes firmly entrenched and self-sustaining.

“Since its last meeting in March, the MPC was encouraged by the further upward revision in the FY21 growth forecast to 3.94 percent.

This confirms the strength of the broad-based economic rebound underway since the start of the fiscal year, on the back of targeted fiscal measures and aggressive monetary stimulus. This positive momentum is expected to persist, translating into higher growth next year.”

The central bank paused rate cuts from September last year. It slashed rates by cumulative 625 basis points till June last to help shield the economy from the effects of the coronavirus lockdown.

Analysts were widely expecting the status quo due to growth uptrend after 0.4 percent contraction during the last fiscal year and inflationary pressures.

Inflation rose to 11.1 percent year-on-year in April, propped up by the lingering impact of this February’s electricity tariff increase as well as a pick-up in month-on-month food prices, partly driven by the usual seasonality around Ramzan.

“Inflation expectations also remain reasonably anchored and wage growth is still muted. This suggests that second-round effects of the prevailing supply-shocks to inflation are not manifesting at the moment,” said the SBP.

“Looking ahead, the inflation trajectory will be affected by the path of domestic food and energy prices, this summer’s round of wage negotiations, next year’s budget, and the strength of the on-going economic recovery.”

The SBP said there is still some spare capacity following last year’s contraction despite the economic recovery. “As previously forecast, the headline year-on-year inflation rate is likely to remain elevated in the coming months due to the recent electricity tariff hike, pushing the average for FY21 close to the upper end of the announced range of 7-9 percent. As supply shocks dissipate thereafter, inflation is expected to gradually fall toward the 5-7 percent target range over the medium-term.”

The State Bank expects monetary policy to remain accommodative in the near term, and any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates over time.

“If demand side pressures emerge as the recovery becomes more durable and the economy returns to full capacity, it would be prudent for monetary policy to begin to normalise through a gradual reduction in the degree of accommodation,” said the SBP. “This would help ensure that inflation does not become entrenched at a high level and financial conditions remain orderly, thereby supporting sustainable growth.”

The SBP said the industrial sector is estimated to have grown 3.6 percent during FY21, driven by construction and large-scale manufacturing, especially the food, cement, textile and automobile sectors.

The current account deficit is expected to remain bounded, modulated by the flexible exchange rate regime, and external financing needs should be comfortably met, further bolstering foreign exchange buffers. At $0.8 billion, the current account has remained in surplus through the first 10 months of FY21 for the first time in 17 years.

The SBP didn’t offer guidance on fiscal deficit. At 3.5 percent of GDP, the fiscal deficit is 0.6 percentage points lower than last year, despite higher interest payments and Covid-related expenses. The primary balance recorded a 1 percent of GDP surplus, its highest level through the first three quarters in 12 years.