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KARACHI: The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) on Thursday decided to raise the policy rate by 125 basis points (bps) to 15 percent with a view to cooling economy, containing inflation and supporting a beleaguered PKR.

The current policy rate is at a 14-year high level as the previous policy rate at the same level was in 2008. In addition, the committee announced that interest rates on EFS and LTFF loans are now being linked to the policy rate to strengthen monetary policy transmission.

The monetary policy decision was announced by SBP Acting Governor Dr. Murtaza Syed in a virtual press conference after the meeting of the MPC held Thursday. He informed media that after 1970 global inflation is witnessing the highest growth. “Globally, inflation is at multi-decade highs in most countries and central banks are responding aggressively, leading to depreciation pressure on most emerging market currencies,” he added.

He appreciated the government’s recent measures including reversal of petroleum subsidy, saying that these steps have paved the way for completion of the IMF loan programme. The expected completion of the ongoing IMF review will catalyze important additional funding from external sources that will ensure that Pakistan’s external financing needs during FY23 are met. Pressures on the rupee should then attenuate and the SBP’s FX reserves should gradually resume their previous upward trajectory during the course of FY23.

He said that GDP growth is expected to moderate to 3-4 percent in FY23, on the back of monetary tightening and fiscal consolidation, helping to close the positive output gap and diminish demand-side pressures on inflation.

Under the MPC’s baseline outlook, the acting governor SBP said that headline inflation is likely to remain elevated around levels of 19-20 percent in FY23 before falling sharply to the 5-7 percent target range by the end of FY24, driven by tight policies, normalization of global commodity prices, and beneficial base effects.

MPS tomorrow: Key policy rate likely to be hiked by 100bps

Going forward, the MPC will remain data-dependent, paying particularly close attention to month-on-month inflation, the evolution of inflation expectations and global commodity prices, as well as developments on the fiscal and external fronts.

Syed said that the increase in key policy rate and linkage of export finance rates with policy rate will ensure a soft landing of the economy amid an exceptionally challenging and uncertain global environment. “It should help cool economic activity, prevent a de-anchoring of inflation expectations and provide support to the Rupee in the wake of multi-year high inflation and record imports”, he added.

Since the last meeting, the MPC noted three encouraging developments. First, the unsustainable energy subsidy package was reversed and an FY23 budget centered on strong fiscal consolidation was passed. This has paved the way for completion of the on-going review of the IMF program, which will ensure that tail risks associated with meeting Pakistan’s external financing needs are averted.

Second, a $2.3 billion commercial loan from China helped provide support to FX reserves, which had been falling since January due to current account pressures, external debt repayments and paucity of fresh foreign inflows. Third, economic activity remains robust, with the momentum of the last two years of near 6 percent growth carrying into the start of FY23. As a result, Pakistan faces a significantly lower trade-off between growth and inflation than many countries where the post-Covid recovery has not been as vigorous.

However, according to the SBP, several adverse developments have overshadowed these positive developments. Globally, inflation is at multi-decade highs in most countries and central banks are responding aggressively, leading to depreciation pressure on most emerging market currencies.

This strong monetary tightening has occurred despite concerns about a slowdown in global growth and even recession risks, highlighting the primacy that central banks are placing on containing inflation at this juncture.

Domestically, as energy subsidies were reversed, both headline and core inflation increased significantly in June, rising to a 14-year high. Inflation expectations of consumers and businesses also rose markedly. At the same time, the current account deficit unexpectedly spiked in May and the trade deficit continued its post-March widening trend to reach a 7-month high in June, on burgeoning energy imports. As a result, FX reserves and the Rupee remained under pressure, further worsening the inflation outlook.

Against this challenging backdrop, the MPC noted the importance of strong, timely and credible policy actions to moderate domestic demand, prevent a compounding of inflationary pressures and reduce risks to external stability. Like most of the world, Pakistan is facing a large negative income shock from high inflation and necessary but difficult increases in utility prices and taxes. Without decisive macroeconomic adjustments, there is a significant risk of substantially worse outcomes that would compromise price stability, financial stability and growth.

The MPC believes that this could take the form of runaway inflation, FX reserve depletion and the need for sudden and aggressive tightening actions later that would be significantly more disruptive for economic activity and employment.

Adjustment is difficult but necessary in Pakistan, as it is all over the world. However, in the interest of social stability, the burden of this adjustment must be shared equitably across the population, by ensuring that the relatively well-off absorb most of the increase in utility prices and taxes while well-targeted and adequate assistance is provided to the more vulnerable.

According to the Monetary Policy Statement issued by the SBP, Pakistan’s strong economic rebound from Covid continues, with the level of output surpassing pre-pandemic levels, unlike in many other emerging markets. The needed moderation in economic activity that was occurring through FY22 in response to monetary tightening has stalled in the last three months, fueled by an unwarranted fiscal expansion.

Most demand indicators suggest robust growth since the last MPS, sales of cement, POL and automobiles increased month-on-month and growth in LSM remains high.

On the external sector side, after moderating in the previous three months, the current account deficit rose to $1.4 billion in May, on the back of lower exports and remittances partly due to the Eid holiday. Non-energy imports have continued to moderate in the last three months on the back of curtailment measures by the resentment and the SBP, this decline has been more than offset by the significant increase in energy imports, which rose from a low of $1.4 billion in February to an estimated record high of $3.7 billion in June.

Without prompt additional measures to curtail energy imports for instance through early closure of markets, reduced electricity uses by residential and commercial customers, and greater encouragement of work from home and car pooling containing the trade deficit could become challenging. With such measures, the current account deficit is projected to narrow to around 3 percent of GDP as imports moderate with cooling growth, while exports and remittances remain relatively resilient.

The fiscal stance in FY22 was unexpectedly expansionary, with the primary deficit estimated at 2.4 percent of GDP, double that of the previous year and more than thrice the budgeted primary deficit of 0.7 percent of GDP.

To compensate for this unwarranted fiscal impulse, this year’s budget targets a primary surplus of 0.2 percent of GDP, on the back of significantly higher tax revenue. This consolidation is appropriate given the very rapid economic growth rate of the previous two years and the need to ensure debt sustainability amid high gross financing needs due to the relatively short maturity of Pakistan’s domestic debt.

According to the SBP, it is critical that the envisaged fiscal consolidation is delivered. It would allow monetary and fiscal policy to resume the well-coordinated approach that characterized Pakistan’s successful Covid response in FY20 and FY21, which supported growth while preserving fiscal and external buffers. At the same time, it is important that the new taxation measures are progressive. In particular, their burden should mainly be absorbed by the relatively better off while adequate protection is provided to the more vulnerable, for whom high food prices are a particular concern. In this context, curbing food inflation through supply-side measures aimed at boosting output and resolving supply-chain bottlenecks should be a high priority, the SBP concluded.

Copyright Business Recorder, 2022


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