The State Bank of Pakistan (SBP) says that it recognises the short-term cost of monetary tightening on economic activity. However, it believes that controlling inflation is crucial for sustainable growth.
The remarks were made by Director Monetary Policy Department, SBP, Fida Hussain, in an episode of the SBP Podcast on Sunday.
Concerning the impact of rising interest rates on economic activity, Fida said that it is pertinent to mention that the SBP’s primary mandate is ensuring price stability.
“Our primary objective is to achieve price stability. Thus, our first concern in decision making context is inflation,” he said.
He said that high inflation creates “an uncertain environment” for consumers and investors to plan their savings and make investment decisions, which would affect growth prospects.
Last week, the central bank announced its Monetary Policy decision, in which it raised the policy rate by 100 basis points and took it to 17%.
Giving the rationale and key reasons behind the latest monetary policy decision, the SBP official highlighted three important factors which the MPC mentioned in its statement.
He said that the first factor is an elevated level of inflation, which went from 26.6% in October to 23.8% in November and stood at 24.5% in December 2022.
“Not only headline inflation but core inflation has also been on a rising trend for the last 10 months, indicating the presence of some demand-side pressures as well as second round impact of earlier energy and food price increases. Furthermore, inflation expectations, among both businesses and consumers, have drifted upwards.
“The MPC noted that if the central bank did not act in the current situation, these expectations may contribute to a further rise in inflation going forward,” he said.
Fida said the second important factor in the MPC decision is that the near-term challenges to Pakistan’s external sector and its outlook have increased, despite the sizable reduction in the current account deficit.
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The third important factor is uncertain global economic conditions.
With regards to food inflation, the podcast highlighted that during the winter months of November and December, shelf life of food products tends to increase, leading to improved supplies and therefore, lower prices.
“However, this was not the case in 2022, as food prices have risen sharply,” said SBP’s official.
He added that this indicates the need for active price monitoring at the local level, and administrative measures to ensure smooth and continuous supplies.
“The higher food inflation and core inflation, if allowed to entrench, creates the risk of a wage price spiral, and therefore necessitates a tight monetary policy response,” said Fida.
The podcast also highlighted that during the “high-inflation period” there is a need for fiscal policy to work in tandem with monetary policy to curtail demand-side pressures.
“If we are raising the interest rate from our side, the fiscal spending side should also reduce,” he said.
He said that an expansionary fiscal policy dilutes the impact of monetary tightening.
“Therefore, adhering to planned fiscal consolidation under the current circumstance would support the SBP’s efforts to curb high inflation.”
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