The State Bank of Pakistan announced on Friday that it had increased the interest rate by 100 basis points (bps) to 16 per cent to curb inflation.

The announcement came after a meeting of the bank’s Monetary Policy Committee (MPC).

The central bank said that the decision was aimed at ensuring that “elevated inflation does not become entrenched and that risks to financial stability are contained, thus paving the way for higher growth on a more sustainable basis”.

The SBP identified higher food and core inflation as “key contributors” to elevated inflation.

The bank maintained growth projections for the financial year 2023 and the current account deficit (CAD) the same as the last policy statement at 2pc and 3pc of GDP, respectively.

According to the SBP press release, the decision to raise the policy rate reflected the MPC’s view that “inflationary pressures have proven to be stronger and more persistent than expected”.

The MPC noted that amid the ongoing economic slowdown, inflation was “increasingly being driven” by persistent global and domestic supply shocks that were raising costs.

“In turn, these shocks are spilling over into broader prices and wages, which could de-anchor inflation expectations and undermine medium-term growth. As a result, the rise in cost-push inflation cannot be overlooked and necessitates a monetary policy response.

“The MPC noted that the short-term costs of bringing inflation down are lower than the long-term costs of allowing it to become entrenched. At the same time, curbing food inflation through administrative measures to resolve supply-chain bottlenecks and any necessary imports remains a high priority,” the press release reads.

The press release added that since its last meeting, the MPC had noted three key domestic developments.

Firstly, it said that headline inflation increased “sharply” in October, as the previous month’s administrative cut to electricity prices was unwound, food prices also “accelerated significantly” due to crop damage from the recent floods and core inflation rose further.

Secondly, the MPC pointed out that a sharp decline in imports led to a “significant moderation” in the current account deficit in both September and October. It added that external account challenges persist despite this moderation and fresh funding from the Asian Development Bank.

However, in a meeting with analysts after the policy announcement, SBP Governor Jameel Ahmad said Pakistan’s foreign exchange reserves would be much higher compared to current levels by the end of the fiscal year, according to a note from Ismail Iqbal Securities.

They governor also told analysts that Pakistan would repay its 2022 Sukuk Eurobond on Dec 2, three days before its maturity on Dec 5, adding that this would not impact reserves as funding had already been rearranged.

Thirdly, it said that while growth and CAD projections were reaffirmed at 2pc and 3pc, average inflation for FY23 was projected at 21-23pc due to higher food prices and core inflation.

Regarding the overall inflation outlook, the MPC said that while inflation was likely to be more persistent than previously anticipated, it was “still expected to fall toward the upper range of the 5-7pc medium-term target by the end of FY24” due to support from “prudent macroeconomic policies, orderly rupee movement, normalising global commodity prices and beneficial base effects”.

“The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth,” the press release added.

Unexpected decision

The central bank’s decision was unexpected as a number of analysts and economists said it was expected to keep the main policy rate unchanged at 15pc in its monetary policy announcement.

All seven experts who spoke to said they expected the central bank to maintain rates, with many pointing out that a slowdown in economic activity had begun and inflation, which has been at a decades-high level in the past few months, would be trending down.

In October, headline inflation clocked in at 26.6pc from a year earlier, reversing the trend witnessed in September when the consumer price index rose 23.2pc, slowing from a four-decade high of 27.3pc in August.

Before today, the central bank raised interest rates by 525 basis points this year, with the last hike of 125 bps coming in July. Since then, the SBP maintained rates in two monetary policy meetings despite no arrest in inflation.

“Inflation is expected to come down going forward as international commodity prices are declining. Current account deficit has been controlled to a large extent,” Fahad Rauf of Ismail Iqbal Securities had said.

“Demand in the economy has eased as evident from high-frequency indicators such as auto sales, cement sales, petroleum sales etc. Thus, we think a further hike at this point is not required,” he added.

More than one analyst had said a fall in international oil prices and an improved current account deficit could also shape the central bank’s decision to halt rates at current levels.

Even though Finance Minister Ishaq Dar, who took over the reins of the economy in September, has indicated that he wants to bring down interest rates, none of the polled experts called for a rate cut at this stage.

“The finance minister has been vocal about his desire for lower rates. Of course, the State Bank is now autonomous and would not be able to follow direct directions from the ministry of finance. But I think that given oil prices have declined, and US inflation has also come down, the government might feel it has room to keep interest rates at the current level,” said Ali Farid Khwaja, Chairman of KTrade Securities.

“The economy is reflecting some results of the increase in rates witnessed so far. Activity has been slowing down. However, we are still in the negative real interest rates zone. So the SBP may opt to continue its wait-and-watch approach,” said Amreen Soorani of JS Global.

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