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Thursday March 28, 2024

Balance of payments, inflation: SBP hikes interest rate by massive 250bps to 12.25pc

By Erum Zaidi
April 08, 2022
The State Bank of Pakistan. Photo: The News/File
The State Bank of Pakistan. Photo: The News/File

KARACHI: The State Bank of Pakistan (SBP) raised the benchmark interest rate 250 basis points to 12.25 percent at an emergency meeting on Thursday, the biggest hike since 1996, as escalating political crisis and higher global oil prices threaten to deepen the economic troubles.

The rupee fell 1.09 percent to touch a record low of 189 against dollar in the interbank market on worsening pessimism about the balance of payments prospects amid sharp erosion in foreign exchange serves and political turmoil, while foreign exchange reserves dropped 5.8 percent to $1.078 billion in the week ended on April 01.

The central bank cited a deterioration in the outlook for inflation and an increase in risks to external stability, heightened by the Russia-Ukraine conflict and domestic political chaos.

“This increases forward-looking real interest rates (defined as the policy rate less expected inflation) to mildly positive territory. The Monetary Policy Committee (MPC) was of the view that this action would help safeguard external and price stability,” the central bank said in its policy statement.

The rate increase was unscheduled as the next policy meeting was scheduled on April 19, but the central bank had warned last month it could meet earlier if needed.

The MPC has revised the average inflation forecast upward to slightly above 11 percent this fiscal year. In the last statement, it expected the inflation to average between 9-11 percent for FY2022.

The SBP expects the current account deficit will still be around 4 percent of GDP in FY2022. “While the non-oil current account balance has continued to improve, the overall current account remains dependent on global commodity prices,” it said.

The SBP decision came hours ahead of a key verdict from the Supreme Court of Pakistan, which ruled that Prime Minister Imran Khan's move to dissolve the National Assembly was unconstitutional.

“The political void created by the dissolution of the National Assembly would make it tougher to convince the International Monetary Fund to disburse the much-needed loan tranche.” The SBP said its strong and proactive policy response was aimed at addressing inflation and the rupee situation.

“Externally, future markets suggest that global commodity prices, including oil, are likely to remain elevated for longer and the Federal Reserve is likely to increase interest rates more quickly than previously anticipated, likely leading to a sharper tightening of global financial conditions,” the SBP said.

On the domestic front, the inflation out turns in March surprised on the upside, with core inflation in both urban and rural areas also rising significantly, according to the SBP.

Meanwhile, rupee touched a record low at 189 in the interbank market on Thursday driven by worsening pessimism about the balance of payments prospects amid sharp erosion in foreign exchange serves and political turmoil.

Rupee ended Thursday’s session at 188.18 to the dollar. It had closed at 186.13 in the previous session. Day-on-day, the local unit fell 1.09 percent. It has depreciated around 6 percent since the no-confidence motion was moved.

In the open market, the rupee hit a new low of 190.50 against the dollar. It finished at 187.70 on Wednesday.

Dealers on the lookout for SBP intervention in the market said they did not see any actions from the central bank to support the currency.

The SBP thinks the situation was not similar to Sri Lanka as exports and remittances were still flowing in. This (rupee's weakness) was merely due to speculation and uncertainty which should settle, according to forex market insiders.

“The SBP has maintained that they want currency to act as a shock absorber,” said Fahad Rauf, the head of research at Ismail Iqbal Securities. “In the current scenario where reserves are eroding, and there is no government to keep a check on fiscal balance, the SBP might not want to use precious reserves to hold the currency.”

The SBP said timely demand-moderating measures and strong exports and remittances saw the February current account deficit shrink to $0.5 billion, its lowest level this fiscal year, “heightened domestic political uncertainty contributed to a 5 percent depreciation in rupee and a sharp rise in domestic secondary market yields as well as Pakistan’s Eurobond yields and CDS spreads since the last MPC meeting”.

Farooq Pasha, Economist MENAP (Middle East North Africa and Pakistan) Financial Markets at Standard Chartered Bank Pakistan Limited, said increased political noise, rising risks to the IMF programme, elevated crude oil prices and slowing remittances were the current external sector pressures.

“Our forecast for USD-PKR by end-FY2022 is 192 and for end-2022 (end December 2022) is 196,” Pasha added.

Meanwhile, the country’s foreign exchange reserves dropped by $1.078 billion in the week ended on April 01. The forex reserves held by the country stood at $17.477 billion, compared with $18.555 billion in the previous week.

The SBP reserves decreased by $728 million to $11.319 billion, largely on debt repayment and the government payment pertaining to settlement of an arbitration award related to a mining project, the central bank said.

“Some of this decline in reserves is expected to be reversed as official creditors renew their loans.”

The reserves of commercial banks also fell by $350 million or 5.4 percent to $6.158 billion. The reserves were at a record high of $20 billion in August 2021.

Analysts estimated that for now the reserves were sufficient to pay for two months of imports.