KARACHI:State Bank of Pakistan’s Monetary Policy Committee (MPC), on Tuesday, decided to increase the policy rate by 100 basis points to 21 percent owing to concerns about high inflationary pressures on the economy.
The MPC, in its meeting, noted that inflation in March 2023 rose further to 35.4 percent and was expected to remain high in the near term and raising the policy rate was an important step towards anchoring inflation expectations around the medium-term target, which is critical for achieving the objective of price stability.
The MPC further observed that Pakistan’s financial sector remains broadly resilient, while economic activity continues to moderate. Besides, three important developments having implications for the macroeconomic outlook took place since the last MPC meeting, it noted.
The current account deficit has narrowed considerably mainly on the back of sizeable import containment while the overall balance of payments position continues to remain under stress, with foreign exchange reserves still at low levels, the committee observed adding that significant progress has been made towards completion of the 9th review under the IMF’s
EFF program as well.
The committee emphasised that the early conclusion of the 9th review under the IMF program was critical to rebuild the FX reserve buffers.
The MPC said further observed that recent strains in the global banking system have led to further tightening of global liquidity and financial conditions and those have added to the difficulties of emerging market economies like Pakistan to access international capital markets.
The MPC in this context considered the current monetary policy stance appropriate and stressed that the recent policy rate hike along with previous accumulated monetary tightening would help achieve the medium-term inflation target over the next 8 quarters.
However, the Committee noted that uncertainties attached to the global financial conditions as well as the domestic political situation pose risks to the assessment.
The MPC further noted that the incoming data on economic activity continues to reflect a broad-based slowdown particularly since there has been a significant decline in sales volumes of automobiles and POL in recent months.
Similarly, the contraction in large-scale manufacturing (LSM) accelerated in January to 7.9 percent year on year basis and cumulatively LSM output was down by 4.4 percent during Jul-Jan FY22-23 as compared to the corresponding period of last year.
Reflecting these trends, electricity generation declined for the ninth consecutive month in February while in agriculture, the information on cotton arrivals remains as per expectation however wheat production target is likely to be missed, the MPC assessed adding that these developments, impact of the recent monetary tightening and new fiscal consolidation measures implemented since the beginning of March, suggest growth in FY23 would be significantly lower than the post-floods assessment of November 2022.
In February 2023, the current account saw a deficit of only $74 million and the cumulative deficit now stood at $3.9 billion in Jul-Feb FY23, about 68 percent lower than the same period last year due to contraction in imports, which continues to outweigh the combined decline in remittances and exports.
The MPC was of the view that workers’ remittances had slightly recovered on m/m basis in February and the momentum was expected to continue in the coming months. However, despite the lower current account deficit, higher loan repayments relative to disbursements were keeping the foreign exchange reserves under pressure, it added.
The MPC viewed that the fiscal outcomes during Jul-Jan FY23 have been encouraging in the context of achieving macroeconomic stability. The fiscal deficit was contained to 2.3 percent of GDP during Jul-Jan FY23 compared to 2.8 percent in the same period last year, while the primary balance posted a surplus of 1.1 percent of GDP against a deficit of 0.3 percent last year.
The improvement in the primary balance was achieved on the back of lower subsidies, grants and development spending, the MPC said adding that growth in tax revenues however had remained below target amidst a slowdown in economic activity, reduction in imports and inadequate policy focus on expanding the tax net, while debt servicing has increased.
In this context, the Committee noted that delivering the envisaged fiscal consolidation is important to complement the ongoing monetary tightening in order to achieve price stability.
Broad money growth showed a slight uptick in February, primarily due to a significant expansion in net domestic assets of the banking system largely on account of higher public sector borrowing as growth in private sector credit decelerated sharply to 11.1 percent in February 2023 from 18.6 percent in February 2022.
On a monthly basis, private sector credit recorded a contraction for the second consecutive month in February due to retirement in fixed investment and consumer loans, while working capital loans saw a marginal seasonal uptick during the month.
National CPI inflation rose to 35.4 percent in March 2023, resulting in average inflation of 27.3 percent during Jul-Mar FY23, the MPC observed and noted that the surge in inflation was broad-based, though a large part of it was contributed by food and energy components.
It reflects the pass-through of increases in taxes and duties, the unwinding of untargeted energy subsidies and the recent exchange rate depreciation, the MPC reviewed.
Importantly, core inflation has risen to 18.6 percent in urban and 23.1 percent in rural baskets, indicating the second-round impacts of the above-mentioned adjustments.
The Committee also viewed the increase in core inflation as partly driven by the elevated inflation expectations, as indicated by recent sentiment surveys.
To anchor these expectations, the MPC viewed its current monetary policy stance as appropriate to keep the real interest rate in positive territory on a forward-looking basis.