KARACHI: The State Bank of Pakistan (SBP) raised its key interest rate by a percentage point to a record 21 per cent on Tuesday as the country attempts to tame crippling food inflation and maintain the confidence of foreign creditors.

The decision to raise the key rate by 100 basis points — below several analysts’ expectations of a 200bps increase — by the central bank’s monetary policy committee (MPC) came days after government data showed March consumer inflation hit another all-time high.

“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,” the SBP said in a statement. “However, there are early indications of inflation expectations plateauing, albeit at an elevated level.”

The committee viewed Tuesday’s rate hike as an important step towards anchoring inflation expectations around the medium-term target, “which is critical for achieving the objective of price stability”, the statement said.

100bps hike below analysts’ expectations

It said that “Pakistan’s financial sector remains broadly resilient, while economic activity continues to moderate”.

The committee said that since the last meeting, it had noted three developments having implications for the macroeconomic outlook — the current account deficit has narrowed, progress towards completing the ninth review under the IMF’s loan programme, and recent strains in the global banking system that have further tightened global liquidity and financial conditions.

“These have added to the difficulties of the emerging market economies like Pakistan to access international capital markets,” it said.

Against this backdrop, the committee said it considered the current monetary policy stance appropriate and stressed that the latest interest rate hike, along with previous accumulated monetary tightening, “will help achieve the medium-term inflation target over the next eight quarters”.

However, the committee noted that uncertainties attached to the global financial conditions as well as the domestic political situation “pose risks to this assessment”.

In its previous policy meeting in March, the SBP raised the rate by a massive 300bps to 20pc. With the latest hike on Tuesday, it has now increased rates by a total of 1,125bps since January last year.

High interest rates are a drag on activity and slow down economic growth. But central banks raise their policy rates out of necessity when inflation gets out of hand.

‘Lower than expected’

The SBP may have held back from a more aggressive rate hike due to indications that a broad economic slowdown is already likely, Reuters quoted Tahir Abbas, head of research at Arif Habib Ltd, as saying.

“A majority of the high-frequency indicators already depict negative growth and a massive slowdown in the economy,” he said. “An aggressive rate hike won’t be of much help.”

Topline Securities CEO Mohammad Sohail said that the hike in the policy rate was “lower than expected”, according to Dawn.com. Raza Jaffrey, head of research at Intermarket Securities, said today’s decision was “in line with our expectations but lower than the street consensus of a 200bps hike”.

External front

Pakistan is in talks with the International Monetary Fund to unlock its next loan tranche worth around $1.1 billion as part of a $6.5bn bailout agreement reached in 2019.

In its statement, the SBP said an early conclusion of the ninth review of the IMF program was critical to rebuilding foreign exchange reserve buffers.

Analysts said the SBP governor stated in a private briefing that principal repayments of $4.5bn remained due during the last quarter of the fiscal year, according to Reuters.

Of that, $2.3bn will be rolled over, while repayments of $2.2bn are payable, the analysts said. Most of the repayments are multilateral and bilateral, with $100 million in commercial loans.

As Pakistan bids to avoid a possible default on foreign obligations, the only help so far has come from long-time ally Beijing, through a $1.8bn refinancing and a rollover of $2bn in March.

Inflation hike ‘broad-based’

In Tuesday’s statement, 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, unwinding of untargeted energy subsidies and the recent exchange rate depreciation,” it said, adding that the core inflation has risen to 18.6pc in urban and 23.1pc in rural baskets, indicating the second-round impacts of measures taken by the government.

The committee also viewed the increase in core inflation as partly driven by the elevated inflation expectations, as indicated by recent sentiment surveys, it said. “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.”

Published in Dawn, April 5th, 2023

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