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State Bank increases interest rate by 100 bps to 21

April 4, 2023 05:02 PM


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State Bank of Pakistan (SBP) Tuesday increased the interest rate by 100 basis points (bps) to 21 per cent, an all-time high in the country in order to arrest ballooning inflation.

According to the 24News HD TV channel, the SBP in its Monetary Policy Statement issued here on Tuesday, at its meeting held on 4th April 2023, the Monetary Policy Committee (MPC) decided to increase the policy rate by 100 basis points to 21 per cent.

SBP Monetary Policy Statement 

The MPC noted that inflation in March 2023 rose further to 35.4 per cent, and is expected to remain high in the near term. However, there are early indications of inflation expectations plateauing, albeit at an elevated level. The MPC views today’s decision as an important step towards anchoring inflation expectations around the medium-term target, which is critical for achieving the objective of price stability. The Committee further observed that Pakistan’s financial sector remains broadly resilient, while economic activity continues to moderate.

Since the last meeting, the Committee noted three important developments having implications for the macroeconomic outlook. First, the current account deficit has narrowed considerably, more than previously anticipated, mainly on the back of sizable import containment. Nonetheless, the overall balance of payments position continues to remain under stress, with foreign exchange reserves still at low levels. Second, significant progress has been made towards the completion of the 9th review under the IMF’s EFF program.

Third, recent strains in the global banking system have led to further tightening of global liquidity and financial conditions. These have added to the difficulties of emerging market economies like Pakistan to access international capital markets.

In this context, the MPC considers the current monetary policy stance appropriate and stresses that today’s decision, along with previous accumulated monetary tightening, will help achieve the medium-term inflation target over the next 8 quarters. However, the Committee noted that uncertainties attached with the global financial conditions as well as the domestic political situation, pose risks to this assessment. 

Real sector

The MPC noted that the incoming data on economic activity continues to reflect a broad-based slowdown. In particular, there has been a significant decline in sales volumes of automobiles and POL in recent months. Similarly, the contraction in large-scale manufacturing (LSM) accelerated in January to 7.9 per cent y/y. Cumulatively, LSM output is down by 4.4 per cent during Jul-Jan FY23 when compared with the corresponding period of last year. Reflecting these trends, electricity generation declined for the ninth consecutive month in February. In agriculture, the information on cotton arrivals remains as per expectation; however, the wheat production target is likely to be missed. These developments, combined with the lagged impact of the recent monetary tightening and new fiscal consolidation measures implemented since the beginning of March, suggest growth in FY23 will be significantly lower than the post-floods assessment of November 2022.

External sector

In February 2023, the current account saw a deficit of only $74 million and the cumulative deficit now stands at $3.9 billion in Jul-Feb FY23, about 68 per cent lower than the same period last year. This mainly reflects the contraction in imports, which continues to outweigh the combined decline in remittances and exports. Importantly, workers’ remittances have slightly recovered on an m/m basis in February and the momentum is expected to continue in the coming months. However, despite the lower current account deficit, higher loan repayments relative to disbursements are keeping the foreign exchange reserves under pressure. Thus, the Committee reemphasized that the early conclusion of the 9th review under the IMF program is critical to rebuilding the FX reserve buffers.

Fiscal sector

The MPC views that the fiscal outcomes during Jul-Jan FY23 have been encouraging in the context of achieving macroeconomic stability. The fiscal deficit was contained to 2.3 per cent of GDP during Jul-Jan FY23 compared to 2.8 per cent in the same period last year, while the primary balance posted a surplus of 1.1 per cent of GDP against a deficit of 0.3 per cent last year. This improvement in the primary balance was achieved on the back of lower subsidies, grants and development spending. Growth in tax revenues, however, has remained below target, amidst a slowdown in economic activity, reduction in imports and inadequate policy focus on expanding the tax net, while debt servicing has increased. In this context, the Committee noted that delivering the envisaged fiscal consolidation is important to complement the ongoing monetary tightening in order to achieve price stability.

Monetary and inflation outlook

Broad money growth showed a slight uptick in February, primarily due to a significant expansion in net domestic assets of the banking system. This was largely on account of higher public sector borrowing as growth in private sector credit decelerated sharply to 11.1 per cent in February 2023 from 18.6 per cent in February 2022. On a monthly basis, private sector credit recorded a contraction for the second consecutive month in February. This contraction was due to retirement in fixed investment and consumer loans, while working capital loans saw a marginal seasonal uptick during the month.

As the MPC had anticipated, national CPI inflation further rose to 35.4 per cent in March 2023, resulting in average inflation of 27.3 per cent during Jul-Mar FY23. The MPC noted that the surge in inflation was broad-based, though a large part of it was contributed by food and energy components. This reflects the pass-through of increases in taxes and duties, the unwinding of untargeted energy subsidies and the recent exchange rate depreciation. Importantly, core inflation has risen to 18.6 per cent in urban and 23.1 per cent in rural baskets, indicating the second-round impacts of the above-mentioned adjustments. The Committee also viewed the increase in core inflation as partly driven by the elevated inflation expectations, as indicated by recent sentiment surveys. To anchor these expectations, the MPC views its current monetary policy stance as appropriate to keep the real interest rate in positive territory on a forward-looking basis.



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