The State Bank on Pakistan (SBP) on Thursday announced an increase of 250 basis points in the benchmark policy rate, taking it to 12.25 per cent in a "strong and proactive policy response".
The SBP's Monetary Policy Committee (MPC) said in a statement that in its last meeting on March 8, it had noted the "significant uncertainty around the outlook for international commodity prices and global financial conditions" which were further exacerbated by the Russia-Ukraine conflict.
"Since the last MPC meeting, the outlook for inflation has deteriorated and risks to external stability have risen," it noted.
"Externally, futures markets suggest that global commodity prices, including oil, are likely to remain elevated for longer and the Federal Reserve is likely to increase interest rates more quickly than previously anticipated, likely leading to a sharper tightening of global financial conditions," the statement said.
Meanwhile, it noted that on the domestic front the inflation in March had "surprised on the upside" with a core inflation in urban and rural areas rising significantly.
It said even though February's current account deficit (CAD) had shrunk to its lowest level in the current fiscal year, but heightened domestic political uncertainty had led to a 5pc depreciation in the rupee.
"In addition, there has been a decline in the SBP’s foreign exchange reserves largely due to debt repayments and government payments pertaining to settlement of an arbitration award related to a mining project."
The MPC said that as a result of the above developments, average inflation forecasts were revised to slightly above 11pc in FY22 the CAD was still expected to be around 4pc of the GDP in FY22 and the overall current account remained dependent on global commodity prices.
The SBP body said the increase in the policy rate was done to respond to the above developments and would serve to "help to safeguard external and price stability" as forward-looking real interest rates would be increased to "mildly positive territory".
In addition, the MPC statement said the SBP was in the process of taking more decisions to reduce pressure on inflation and the current account. It said the announcement of these measures was expected soon and would complement Thursday's increase in the policy rate.
"Importantly, the MPC highlighted that Pakistan’s external financing needs in FY22 are fully met from identified sources. Looking ahead, the MPC noted that today’s decisive actions, together with a reduction in domestic political uncertainty and prudent fiscal policies, should help ensure that Pakistan’s robust economic recovery from Covid-19 remains sustainable," the statement said.
