• Central bank surprises market by hiking policy rate by 150 basis points
• Says goal of ‘mildly positive real interest rates’ remains unchanged

KARACHI: The State Bank of Pakistan raised the policy interest rate by 150 basis points to 8.75 per cent on Friday, as “the balance of risks has shifted away from growth and towards inflation and the current account faster than expected”.

The central bank announced its monetary policy a week earlier than the scheduled date in an attempt to address the situation going out of control with higher inflation, rising current account deficit, disrupted exchange rate and negative real interest rate. The quantum of the hike also surprised the market.

The new policy interest rate is 8.75pc, close to October’s inflation of 9.2pc.

Interest rates are used by the central bank to control inflation, regulate unnecessary movements in currency rates and guide the national economy.

Since the last meeting held in September, “risks related to inflation and the balance of payments have increased,” the SBP said in a statement.

With respect to the balance of payments, the current account deficits in September and October have been larger than anticipated, reflecting both rising oil and commodity prices and buoyant domestic demand, the bank said. “The burden of adjusting to these external pressures has largely fallen on the rupee.”

Across the world, price pressures from Covid-induced disruptions to supply chains and higher energy prices are proving to be larger and longer-lasting than previously anticipated, it said. “In Pakistan, high import prices have contributed to higher-than-expected CPI [consumer price index], SPI [sensitive price indicator], and core inflation outturns.”

The SBP stressed the need to proceed faster to normalise monetary policy to counter inflationary pressures and preserve stability with growth. “The interest rate increase is a material move in this direction,” it said.

It said the end goal of mildly positive real interest rates remains unchanged and, given today’s move, expects to take measured steps to that end.

The SBP said the economic recovery underway since the start of the 2020-21 fiscal year continues, as reflected in most high-frequency indicators of domestic demand including automobile sales, POL (petroleum, oil and lubricants) sales, and electricity generation as well as the strength of imports and tax revenues.

The LSM registered a broad-based growth of 5.2pc year-on-year in the July-September quarter, led by production of consumer goods (both durable and non-durable), allied construction, and export industries, it added.

“In agriculture, production levels of all major Kharif crops except cotton are estimated to have reached all-time highs,” said the SBP.

The SBP said economic recovery appears increasingly durable and self-sustaining overall against the backdrop of rapidly falling Covid-19 cases and the government’s vigorous roll-out of the vaccination.

Looking ahead, rising input costs and the normalization of macroeconomic policies are likely to lead to some moderation in the growth of industrial activity, it added.

“This could be more than offset by the improved outlook for agriculture, such that risks to the growth forecast of 4-5pc in FY22 are tilted to the upside,” said the SBP.

As a result of these developments, the balance of risks has shifted away from growth and towards inflation and the current account faster than expected, it added.

There was also a moderate month-on-month decline in exports and remittances, it said adding that the current account deficit for FY22 is expected to modestly exceed the previous forecast of 2-3pc of GDP. The current account deficit has already exceeded the forecast as it reached 4.1pc in the first quarter of the current fiscal year.

The SBP defended the market-based exchange rate and said it has played its due role as a shock absorber while it has borne a considerable burden in terms of adjusting to the widening current account deficit.

“The fall in the value of the rupee since May has been comparatively large. As other adjustment tools normalize, including interest rates and fiscal policy, pressures on the rupee should abate,” the SBP said.

The overall fiscal deficit improved to 0.8pc of GDP in the July-September quarter from 1pc in the same period a year ago but non-tax revenue fell by 22.6pc year-on-year due to a sharp decline in petroleum development levy collection.

A higher-than-planned primary fiscal deficit would likely worsen the outlook for inflation and the current account, and would undermine the durability of the recovery, the central bank said.

It added that the primary surplus was 28.6pc lower than in the first quarter of previous fiscal year due to a 33pc growth in non-interest spending.

The SBP said that in the last two months inflation significantly increased by 2pc while the core inflation has also risen to 6.7pc in both urban and rural areas on the back of house rents, cloth and garments, medicines, footwear, and other components.

Published in Dawn, November 20th, 2021

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