As expected, the SBP kept the policy rate unchanged at 11.5 percent. Overall, the stance is hawkish, and barring any shock—whether from energy prices or climate-related events—inflation is likely to taper off over the next few months.
Analysts, and perhaps the SBP, expect inflation next year to remain between 7 and 9 percent, which is higher than the SBP’s medium-term target range of 5–7 percent. Hence, maintaining real rates of 2–3 percent is prudent.
At the same time, the SBP expects growth to pick up and believes—although it will reveal its forecast next month—that it could exceed 4 percent next year, higher than the government’s own estimate. Thus, growth is coming, albeit slowly. The SBP must ensure that the economy does not overheat, and a cautious stance is warranted for that.
There are two ways to deal with this. As some economists argue, the currency could be allowed to depreciate while interest rates are brought down. This would support export-led growth in its true sense and could maintain a delicate balance. However, given the political compulsion to maintain a sticky exchange rate, the SBP must keep real rates high.
Thus, barring any shock, the SBP should keep the policy rate unchanged over the next few months.
Monetary policy is complementing the budget, which is essentially a relief budget. The Monetary Policy Committee believes that the budget is not expansionary or inflationary. Rather, it views the budget as supportive of the industrial sector and exports. Some are of the view that deferred investment, perhaps even in balancing, modernisation and replacement, may now take place. That is positive, and excessive tightening could be detrimental. Hence, the committee did not opt for a 50-basis-point hike, although there may have been a voice in favour of it.
The SBP is comfortable with the build-up of reserves, as the governor expects the total to cross $18 billion by June, providing 2.7 months of import cover. He wants to continue buying dollars from the interbank market, with the next goal being to reach three months of import cover. Some believe that the SBP is also curbing so-called non-essential imports to keep the overall bill in check. Channel checks with the auto sector and banks confirm the SBP’s comfort with growing automobile imports, which are close to an all-time high.
Whatever formula the SBP is adopting appears to be working, as there is no panic and all official payments are being honoured. The key is to keep inflation under control and maintain sanity in the external account while the economy grows at a slow pace.
The SBP perhaps desires export-led growth. The concessional financing rate for exporters has been slashed by 1 percentage point, which has to be absorbed by banks that are behaving like good boys. The government has reduced tax rates for exporters, while banks are providing cheaper financing. That gives the SBP room to maintain positive real rates—along with a tarka of administrative controls—to ensure that the economy does not overheat because of domestic demand.
There are some concerns about rising food prices, particularly wheat, whose price historically dips after harvesting. However, it is moving in the opposite direction. One way to address this is by opening wheat imports—or at least creating the threat of imports—as international prices are low.
The key risks relate to the unfolding of the budget and the continuation of the soft deal between Iran and the US. The budget numbers do not add up. Tax revenues are likely to fall short, which could affect the one-time grant to be provided by the provinces. Any fiscal slippage could have inflationary consequences, and the SBP must watch out for that.
Energy prices could also rise again if the truce in the Middle East ends. Moreover, this could have medium-term implications for home remittances, which reached an all-time high last month.
The SBP must closely watch all these risks over the next few months and should maintain the policy rate before considering a shift into higher growth gear.
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