- MPC says decision reflects view that inflationary pressures have proven to be stronger and more persistent than expected
- Majority of market participants had anticipated central bank to maintain key policy rate
In a development that is likely to surprise followers, the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) raised the key interest rate by 100bps, taking it to 16%, the highest since 1998-1999.
The development comes against market expectations as a majority of participants had anticipated the central bank to maintain status quo at 15%.
"At today’s meeting, the Monetary Policy Committee (MPC) decided to raise the policy rate by 100 basis points to 16 percent," the MPC said.
"This decision reflects the MPC’s view that inflationary pressures have proven to be stronger and more persistent than expected. It is aimed at ensuring that elevated inflation does not become entrenched and that risks to financial stability are contained, thus paving the way for higher growth on a more sustainable basis."
Rise in cost-push inflation cannot be overlooked and necessitates a monetary policy response: MPC of the SBP
The MPC was of the view that amid the ongoing economic slowdown, inflation is increasingly being driven by persistent global and domestic supply shocks that are raising costs.
"In turn, these shocks are spilling over into broader prices and wages, which could de-anchor inflation expectations and undermine medium-term growth.
“As a result, the rise in cost-push inflation cannot be overlooked and necessitates a monetary policy response."
The MPC noted that the short-term costs of bringing inflation down are lower than the long-term costs of allowing it to become entrenched.
"At the same time, curbing food inflation through administrative measures to resolve supply-chain bottlenecks and any necessary imports remains a high priority.”
The central bank MPC noted several key developments since the last MPC in October.
“First, headline inflation increased sharply in October, as the previous month’s administrative cut to electricity prices was unwound. Food prices have also accelerated significantly due to crop damage from the recent floods, and core inflation has risen further.
“Second, a sharp decline in imports led to a significant moderation in the current account deficit in both September and October. Despite this moderation and fresh funding from the ADB, external account challenges persist.
“Third, after incorporating the Post-Disaster Needs Assessment of the floods and latest developments, the FY23 projections for growth of around 2 percent and a current account deficit of around 3 percent of GDP shared in the last monetary policy statement are re-affirmed. However, higher food prices and core inflation are now expected to push average FY23 inflation up to 21-23%.”
Food prices have also accelerated significantly due to crop damage from the recent floods, and core inflation has risen further: MPC of the SBP
Monetary and inflation outlook
The MPC noted that headline inflation rose by almost 3.5 percentage points in October to 26.6% percent (y/y), driven by a normalisation of fuel cost adjustments in electricity tariffs and rising prices of food items.
The central bank has revised upwards its inflation projections for FY23.
“While inflation is likely to be more persistent than previously anticipated, it is still expected to fall toward the upper range of the 5-7% medium-term target by the end of FY24, supported by prudent macroeconomic policies, orderly Rupee movement, normalizing global commodity prices and beneficial base effects."
The SBP had kept the rate unchanged at its last two meetings in October and September.
Since the last MPC meeting held in October, a number of key economic developments on the domestic front have taken place.
Inflation, current account deficit
Consumer Price Index (CPI)-based inflation registered a significant increase in October 2022 and clocked in at 26.6% on a year-on-year (YoY) basis, primarily due to normalisation of electricity tariff, quarterly house rent revision, and higher perishable food prices.
On a month-on-month basis, it increased 4.7%, showed data released by the Pakistan Bureau of Statistics.
Meanwhile, the Sensitive Price Indicator (SPI)-based inflation in the week ended November 24 recorded an increase of 0.48% due to an increase in prices of food items.
Pakistan’s current account deficit (CAD) shrank by 46.8% during the first four months of this fiscal year (FY23) due to a lower import bill and marginal increase in exports.
Deficit during October alone clocked in at $567 million, which is 56% higher on a month-on-month basis.
Decline in the current account deficit comes as imports reduced by $2.7 billion (or 11.6%) and exports increased by $0.2 billion (or 2.6%) compared to Jul-Oct 2021, the SBP said.
Foreign exchange reserves and currency
Moreover, foreign exchange reserves held by the central bank have declined to $7.83 billion as of November 18, 2022, according to latest data.
In the period since the last MPC, the currency has been trading in a range between Rs218 and 224 against the US dollar.