Recall the last policy announcement back in September, when the market at large was expecting the discount rate to stay constant despite the elevated inflationary expectations, thin foreign exchange reserves and poor state of the Balance of Payments.
Their expectations for status quo in the discount rate were based on the Letter of Intent to the IMF which included the policymakers intention to pursue an "accommodative policy stance". However, SBP and MoF had a different interpretation for "accommodative policy stance"; a hike of 50 basis points which otherwise could have been much steeper.
Unlike the jolt that the last monetary policy gave to the market, SBPs decision was much more aligned market expectations this time around. With the IMFs directives of controlling currency slippages via monetary tightening and not through market intervention, a hike of 50-100 basis points was largely anticipated by the market.
In a survey conducted by BR Research, a day before the policy announcement, the majority of participants expected SBP to take the discount rate tally to 10.5 percent against the earlier rate of 9.5 percent. However, the final decision hit the lower side of the market consensus, i.e. the rise of 50 basis points.
Industry insiders and analysts believed that a steep one-time hike in the policy rate instead of a gradual rise could have averted the markets bias towards short-term government papers and helped build the long-term yield curve. Besides, this would have lured savings and halted dollarization by pushing the real interest rates to as high as 2.2 percent, given the four-month average CPI of 8.3 percent.
On the dark side, however, an abrupt hike of 100-150 basis points would have discouraged private sector credit off-take which had started showing signs of improvement given monetary expansion over the past two years.
Besides, a bigger hike would have resulted in much severe capital losses to banks which have parked significant proportions of their funds in government securities. The cost of deposits for banks would also have risen exorbitantly amid minimum rate on saving deposits (MDR) linked with the discount rate.
Keeping in view all the pros and cons of a hasty rate-hike, SBP remained reasonable and raised the mark by just 50 basis points. The banks which otherwise would have welcomed a steep hike must have heaved a sigh of relief on the moderated uptick.
Although SBP has revised down its FY-end inflationary expectations to 11-11.5 percent against the earlier forecast of 12 percent, a further hike of 100-150 basis points in the benchmark rate cannot be ruled out for the next three policy announcements due this year to keep real interest rates positive.
This might spur speculative activities and keep investment concentrated in short-term instruments to avoid revaluation losses once the rate rises. While the rate hikes may be unwelcome for private sector credit off-take, there are more crucial issues than the benchmark rate; that must be resolved to boost private sectors growth. One such issue is the flagging rupee-dollar parity and thin foreign reserves position, which, if not tackled through accurate policy stance, could further magnify the fiscal woes.
Whether the central bank sticks to a gradual tightening trend or notches up the rate by a steeper climb in coming MPS announcements will be heavily dependent on inflation in coming months as well as the strength of the BoP.
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