KARACHI: The State Bank of Pakistan (SBP) on Monday raised interest rates by 150 basis points to 13.75 percent, the second hike in less than two months, stepping up its battle against a deteriorating inflation outlook after the government moved to loosen billions of rupees in fuel subsidy.
“This action, together with much needed fiscal consolidation, should help moderate demand to a more sustainable pace while keeping inflation expectations anchored and containing risks to external stability,” the central bank said in a policy statement.
The policy rate has been increased by 400 bps since April 7. The central bank has delivered a big 675 bps raise in interest rates since September 2021.
The country is going through economic turmoil, including high inflation, reserves declining to as low as less than two months of imports and a fast-weakening currency. The government's indecisiveness on withdrawal of unfunded subsidies in the oil and power sector deepens doubt over quick resumption of the IMF bailout programme – a lifeline for the country’s fragile economy. The loan talks between the IMF’s staff and Pakistan’s authorities are underway in Doha. On a successful completion of the seventh, the country will secure a $900 million tranche of the $6 billion Extended Fund Facility.
“... external pressures remain elevated and the inflation outlook has deteriorated due to both home-grown and international factors,” the SBP said. “Globally, inflation has intensified due to the Russia-Ukraine conflict and renewed supply disruptions caused by the new Covid wave in China. As a result, almost all central banks across the world are suddenly confronting multi-year high inflation and a challenging outlook.”
The statement said the MPC’s baseline outlook assumes continued engagement with the IMF, as well as reversal of fuel and electricity subsidies together with normalization of the petroleum development levy (PDL) and GST taxes on fuel during FY2023.
“Under these assumptions, headline inflation is likely to increase temporarily and may remain elevated throughout the next fiscal year.” Thereafter, it is expected to fall to the 5 to 7 percent target range by the end of FY24, driven by fiscal consolidation, moderating growth, normalization of global commodity prices, and beneficial base effects.
At the same time, the SBP emphasized the urgency of strong and equitable fiscal consolidation to complement monetary tightening actions. This would help alleviate pressures on inflation, market rates and the external account.
“As electricity and fuel subsidies are reversed, inflation is likely to rise temporarily and may remain elevated through FY23 before declining sharply during FY24. This baseline outlook is subject to risks from the path of global commodity prices and the domestic fiscal policy stance.”
The SBP said an expansionary fiscal stance had pressures on the exchange rate during the current fiscal.
“Domestically, an expansionary fiscal stance this year, exacerbated by the recent energy subsidy package, has fueled demand and lingering policy uncertainty has compounded pressures on the exchange rate,” it added.
The statement said provisional estimates suggest that growth in the fiscal year 2022 has been much stronger than expected.
“GDP is forecast to accelerate to 5.97 percent this fiscal year versus 5.7 percent last year and 0.9 percent contraction in FY2020.”
The SBP expects the growth rate to moderate to 3.5-4.5 percent in the next fiscal year on the back of monetary tightening and assumed fiscal consolidation.
The SBP also expects the current account deficit to clock in at 4 percent of GDP in FY2022. This is expected to compress to 3 percent of GDP next year as import growth contracts, demand shows moderation and recent measures undertaken to curtail non-essential imports show results alongside resilient exports and remittances.
“This narrowing of the current account deficit together with continued IMF support will ensure that Pakistan’s external financing needs during FY23 are more than fully met, with an almost equal share coming from rollovers by bilateral official creditors, new lending from multilateral creditors, and a combination of bond issuances, FDI and portfolio inflows,” it said. “As a result, excessive pressure on the Rupee should attenuate and SBP’s FX reserves should resume their previous upward trajectory during the course of the next fiscal year.”
Mehtab Haider adds: Former advisor of finance Dr Khaqan Najeeb, meanwhile, told The News that the authorities have had to revert to tightening measures to moderate growth and inflation and manage the burgeoning current account deficit. The recent round of monetary tightening of a hike of 150 basis points in policy rate comes at the back of 13.4 percent headline inflation in April, a two- year high. Inflation momentum is high at 1.6 percent month on month. With a hike of 150bps in interest rate at 13.75%, Pakistan’s real interest rate turns marginally positive from being negative in previous months.
He emphasised that monetary tightening has to be accompanied by much needed fiscal consolidation to ensure external account stability and tapering of inflation. Monetary and fiscal policies have to work in tandem. In Pakistan, an expansionary fiscal stance in FY22 has been further increased by the on-going energy subsidies which have risen much beyond initial estimates and have fuelled higher consumption and an air of uncertainty- all this has put undue pressures on the exchange rate. The government needs to take an appropriate targeted subsidy approach to move to fiscal consolidation so that further pressure on increasing the policy rate is averted.
He concluded by saying that ongoing tightening measures are likely to slow the growth of current account deficit in coming months; however, inflation is more entrenched and is driven by domestic supply side constraints and by international price pass-throughs. It may be more resilient and take a longer duration to moderate. It is important that Pakistan design its monetary and fiscal policy actions which are in-line with the expectation of the country to remain engaged with the IMF programme, the economist added.
