KARACHI: The State Bank of Pakistan (SBP) increased the policy rate by 25 basis points to six per cent to pre-empt the overheating in the economy and inflation breaching its target rate.

Announcing the monetary policy for the next couple of months on Friday, SBP Governor Tariq Bajwa said the decision to increase the interest rate was taken as a pre-emptive measure to protect the economy from overheating.

The interest rate had stayed unchanged since May 2016. This helped the private sector use cheaper money to achieve better performance as reflected by record growth in its credit off-take in 2016-17.

Policy rate up by 0.25pc to 6pc

“(This) is the right time to make a policy decision that would balance growth and stability in the medium to long term,” he said.

He said economic growth is on track to achieve its highest level in the last eleven years. Average headline inflation remains within the forecast range of the SBP, but core inflation has continued to increase, said the governor.

“The fiscal deficit for the first half of 2017-18 is expected to fall close to the last year’s 2.5pc,” he said.

There has been a visible improvement in exports and remittances are marginally higher, he said, adding that the current account deficit remains under pressure largely due to a high level of imports.

“The exchange rate adjustment in December 2017 is expected to help ease the pressure on the external front,” he said.

He said the agriculture sector performed well as Kharif crops surpassed the level of 2016-17. Similarly, the large-scale manufacturing (LSM) sector recorded a growth of 7.2pc in July-November compared to 3.2pc a year ago.

“After incorporating the impact of commodity sector dynamics on the services sector, the real GDP growth is projected to be around 5.8pc, significantly higher than 2016-17, but marginally lower than the annual target of 6pc for 2017-18,” Mr Bajwa said.

This is largely due to expectations of a below-target wheat crop because of a reduction in the area under cultivation, he added.

Average headline inflation for July-December stands at 3.8pc. Meanwhile, core inflation (non-food, non-energy) continued to maintain its higher trajectory, and clocked in at 5.5pc during the first half of the year compared to 4.9pc last year.

“This together with a lagged impact of rupee depreciation and rising international oil prices are likely to increase inflation in the coming months,” he said.

He said that while average inflation for 2017-18 is still projected to fall in the range of 4.5pc to 5.5pc, inflation at the end of the fiscal year is likely to inch towards the annual target of 6pc.

He said export receipts posted the growth of 10.8pc in July-December, highest in the last seven years, against a reduction of 1.4pc a year ago. Workers’ remittances also recorded a growth of 2.5pc during the first half of the fiscal year.

“However, the favourable impact of these positives was overshadowed by the continuation of strong growth in imports of goods and services,” said Mr Bajwa.

The current account deficit widened to $7.4 billion during the first half of the fiscal year, which was 1.6 times of the deficit during the same period of 2016-17.

Developments in financial accounts show that one-fifth of this deficit was financed by foreign direct investment inflows, and the rest was managed by official flows and the country’s own resources.

“As a result, the SBP’s liquid foreign exchange reserves witnessed a decline of $2.6bn since end-June 2017,” he said.

“Rupee depreciation in December, export package, lagged impact of adjustments in regulatory duties, favourable external environment and expected increase in workers’ remittances will contribute to a gradual reduction in the country’s current account deficit,” he said.

While the increase in international oil prices poses a major risk to this assessment, managing the overall balance of payments in the near term depends on the realisation of official financial flows, said the governor.

Four key factors of the national economy have witnessed important changes since November 2017 impinging upon the policy rate decision, said the governor.

Firstly, the rupee has depreciated by around 5pc. Secondly, oil prices are hovering near $70 per barrel. Thirdly, many central banks have started adjusting their policy rates upwards adversely affecting the rupee interest-rate differentials vis-à-vis their currencies. Fourthly, multiple indicators show that the output gap has significantly narrowed, indicating a build-up of demand pressures.

Responding to a question, Mr Bajwa said currency devaluation in one go was better than gradual devaluation. He said gradual devaluation does not indicate how long it will continue, which can hurt confidence of economic stakeholders.

Talking about currency swap agreements with China and Turkey, he said there is no practical movement in the case of Turkey while more steps are needed to make the mechanism more useable in the case of China. He said some concrete measures will soon be taken in this regard.

He said there was no currency swap agreement with Iran, adding that no step has been taken in this regard. However, there was understanding with Iran to establish banking relations and private banks need to step forward for the facilitation of bilateral trade.

Published in Dawn, January 27th, 2018