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Thursday January 20, 2022

To counter inflationary pressures, SBP hikes policy rate by 150bps to 8.75pc

The SBP made a sharp increase in the policy rate to ensure the growth remains sustainable while gradually targeting mildly positive interest rates over time

November 20, 2021

KARACHI: The State Bank of Pakistan (SBP) Friday raised its benchmark interest rate by 150 basis points (bps) to 8.75 per cent, higher than market’s expectations, amid heightened risks stemming from inflation and the balance of payments.

At a preponed meeting, the SBP made a sharp increase in the policy rate to ensure the growth remains sustainable while gradually targeting mildly positive interest rates over time. It has raised the policy rate by 175 bps during the last two months.

The SBP’s Monetary Policy Committee (MPC) thinks that since the last meeting, risks related to inflation and the balance of payments, have increased while the outlook for growth has continued to improve.

The SBP said there are upside risks to GDP growth of 4-5 per cent because of the improved outlook for agriculture. The SBP said risks related to inflation and balance of payments come from both global and domestic factors. Across the world, price pressures from Covid-induced disruptions to supply chains and higher energy prices are proving to be larger and longer-lasting than previously anticipated.

“In response, central banks have generally begun to tighten monetary policy to keep inflation expectations anchored. In Pakistan too, high import prices have contributed to higher-than-expected CPI, SPI, and core inflation outturns,” it said in a monetary policy statement.

At the same time, there are also emerging signs of demand-side pressures on inflation and inflation expectations of businesses have risen on account of further upside risks from domestic administered prices, it aided.

With respect to the balance of payments, the current account deficits in September and October have been larger than anticipated, reflecting both rising oil and commodity prices and buoyant domestic demand, it said.

“The burden of adjusting to these external pressures has largely fallen on the rupee.” As a result of these developments, the balance of risks has shifted away from growth and toward inflation and the current account faster than expected, it explained.

Accordingly, the MPC was of the view that there is now a need to proceed faster to normalise monetary policy to counter inflationary pressures and preserve stability with growth. “Today’s rate increase is a material move in this direction. Looking ahead, the MPC re-iterated that the end goal of mildly positive real interest rates remains unchanged and, given today’s move, expects to take measured steps to that end.”

The SBP expects the current account deficit overshooting the initial 2-3 per cent of GDP forecast in FY2022, while it sees global commodity prices and potential further upward adjustments in administered prices of energy pose upside risks to the average inflation forecast of 7-9 per cent this fiscal year.

In its new forward guidance, it said looking ahead, the MPC reiterated that the end goal of mildly positive real interest rates remains unchanged and, given today’s move, expects to take measured steps to that end.

The major increase in the interest rates seems to be the part of the prior actions for completion of the sixth review under the International Monetary Fund (IMF) loan programme, which will pave the way for the disbursement of $1 billion loan tranche.

“We had highlighted in our earlier report that a much higher increase in the policy rate is possible if the SBP is targeting to achieve mildly positive real interest rates. We believe another 50-100bps is possible from here during FY22 with average inflation likely to average 10 YoY in FY22,” said an analyst at Topline securities.

During the day, the central bank also released current account data which posted a deficit of $1,663 million for the month of October 2021 compared to a surplus of $448 million in the same month of the last year.

Interest rates are used by the central bank as a tool to control inflation, regulate unnecessary movements in currency rates and give guidance to the national economy.

In its previous policy review, the central bank had increased the benchmark policy rate by 25 bps to 7.25%. Accordingly, the real interest rate (inflation reading subtracted from the benchmark interest rate) was recorded at negative 2%, as inflation reading came in at 9.2% in October.

In its pre-monetary policy commentary, Arif Habib Limited had stated that the SBP is expected to remain hawkish, raising its policy rate for the second time since the beginning of FY22 and at a much higher magnitude of 100bps — the highest hike in more than 2 years — taking the total cumulative increase in FY22 to date to 125 bps.

The brokerage house had predicted that a shift towards a more hawkish stance from earlier “gradual and calibrated” one might be evident in this monetary policy meeting as inflation worries are rumbling more clearly than before.

Inflation in Pakistan has increased markedly with the resumption of economic activities but as supply-side inflation has subsided, demand-side inflation has overshot. Headline inflation initially remained low averaging at 8.7 percent during 4MFY22, but now, even with the base effect waning, it has started accelerating, raising concerns. 

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