KARACHI: The central bank Monday raised its benchmark interest rate by 25 basis points to 7.25 percent, embarking on a monetary tightening cycle to combat growing price pressures in the aftermath of the COVID-19 pandemic and stood ready to take further steps to tackle inflationary risk if necessary.
The unexpected rate hike, first since mid-2020, surprised most market participants who expected the bank would hold the rate steady. Dr Reza Baqir, central bank governor, said the bank had maintained the policy rate at 7 percent for the last 15 months.
"The economy is recovering on a strong and sustained basis and the pace the economy is gaining recovery is higher than the MPC’s (Monetary Policy Committee) expectations ... which reflects on imports and the current account deficit,” Baqir said in a video message.
“Since our exchange rate is market-based, it works as a shock absorber. Due to this, the current account deficit [CAD] remains sustainable, but along with exchange rate adjustment the MPC thought that other policies and tools like interest rates should be used,” he said.
"In upcoming meetings, any change in the policy would be gradual. If the MPC thinks appropriate it would take action to moderate demand growth."
The State Bank of Pakistan (SBP) in its monetary policy statement also signaled that it could raise rates in coming months as a stimulus to support the economy due to the COVID crisis but "any future decision would be based on the coming demand growth and other key data".
It said looking ahead, in the absence of unforeseen circumstances, the MPC expects monetary policy to remain accommodative in the near term, with possible further gradual tapering of stimulus to achieve mildly positive real interest rates over time.
"The pace of this possible further gradual tapering, the MPC sees, would be informed by updated information on the continued strength of demand growth and the stance of fiscal policy, amongst other factors."
Khurram Schehzad, CEO of Alpha Beta Core, said the central bank’s decision to increase interest rates could slow down growth. "I wonder what 25bps increase will achieve, except that it will put a burden on the government finances again," Schehzad said.
"(It will have) a negative impact on the private sector which in term will increase inflation further, quicker phasing out of government’s rate subsidies on Roshan Apna housing and all such projects, and only beneficiaries would be banks in terms of profits on the government papers and they are 65-70 percent invested in Tbills/PIBs.”
The central bank said year-on-year inflation had declined since June, but rising demand pressures together with higher imported inflation could begin to manifest in inflation readings later in the fiscal year.
Inflation fell from 9.7 percent year-on-year in June to 8.4 percent in both July and August. Looking ahead, the inflation outlook largely depends on the path of domestic demand and administered prices, notably fuel and electricity, as well as global commodity prices, it noted.
The bank said the economic recovery now appears less vulnerable to pandemic-related uncertainty as the latest COVID wave in Pakistan remains contained.
“As a result, at this more mature stage of recovery, a greater emphasis is needed on ensuring the appropriate policy mix to protect the longevity of growth, keep inflation expectations anchored, and slow the growth in the current account deficit.“
In line with this shift in the economic outlook, the MPC was of the view that the priority of monetary policy also needed to gradually pivot from catalyzing the recovery after the COVID shock toward sustaining it.
As foreshadowed in previous monetary policy statements, the MPC noted that this rebalancing would be best achieved by gradually tapering the significant monetary stimulus provided over the last 18 months.
The MPC noted that over the last few months the burden of adjusting to the rising current account deficit had fallen primarily on the exchange rate and it was appropriate for other adjustment tools, including interest rates, to also play their due role.
The central bank’s move follows a recent depreciation in the rupee driven by higher imports which in turn widened the current account gap.
The current account deficit rose to $0.8 billion in July and $1.5 billion in August, reflecting both vigorous domestic demand and high global commodity prices, according to the central bank.
Geo reports: The statement added that remittances remained strong, growing by 10.4pc during July-August and exports also performed "reasonably well" (averaging $2.3b per month), as they were outstripped by imports.
"As a result, the rupee depreciated by 4.1pc since the last MPC meeting. The MPC noted that many other currencies have also depreciated recently as expectations of tapering by the federal reserve have been brought forward," the statement said.
The MPC observed that while the flexible exchange rate had appropriately played its role as a shock absorber, it is important that its role be complemented by strong exports, targeted measures to curb non-essential imports, and appropriate macroeconomic policy settings to contain import growth.
The SBP expects GDP growth in FY22 toward the upper end of the forecast range of 4-5 percent, notwithstanding some greater uncertainty with respect to spillovers from the evolving situation in Afghanistan.
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