KARACHI: In the biggest hike in years, the State Bank of Pakistan (SBP) raised its policy rate by 250 basis points to 12.25 per cent in an emergency meeting on Thursday and the bank said in a statement that more steps like an increase in export refinancing rates and cash margin on imports will be announced soon.

The SBP cited a deterioration in the outlook for inflation and an increase in risks to external stability, heightened by the Russia-Ukraine conflict, as well as political uncertainty at home.

The hike was unscheduled as the next monetary policy committee (MPC) meeting was set for late April. However, the bank warned last month that it could meet earlier than expected to safeguard external and price stability.

The increase in the policy rate was expected since returns on treasury bills and Pakistan Investment Bonds were well ahead of the policy rate, and the Karachi Inter-Bank Offered Rate (Kibor) was also much higher.

The six-month Kibor was at a two-year high of 13.19pc, up 200 basis points since March 8 when the no-confidence motion against Prime Minister Imran Khan was moved in the National Assembly.

On Wednesday, the rate of three-month T-bills jumped by 80bps to 12.8pc, that of benchmark six-month T-bills by 75bps to 13.25pc, and that of 12-month papers rose to 13.3pc. All these indicators were pointing towards an increase in the policy interest rate.

The MPC noted that these developments necessitated a strong and proactive policy response, said the SBP, adding that this increased forward-looking real interest rates (defined as the policy rate minus expected inflation) to mildly positive territory.

“Since the last MPC meeting, the outlook for inflation has deteriorated and risks to external stability have risen,” the central bank said in a statement on Thursday.

“Futures markets suggest that global commodity prices, including oil, are likely to remain elevated for longer and the [US] Federal Reserve is likely to increase interest rates more quickly than previously anticipated,” it said.

Domestically, the SBP said the March inflation turnout was higher than expected and political uncertainty had worsened matters.

“Heightened domestic political uncertainty contributed to a 5pc depreciation in the rupee and a sharp rise in domestic secondary market yields as well as Pakistan’s Eurobond yields and CDS [credit default swap] spreads since the last MPC meeting,” the bank said.

The exchange rate also reflected the political uncertainty, as the dollar jumped 1.09pc on high demand to close at Rs188.18 in the interbank market on Thursday.

The SBP also pointed to pressure from a sharp drop in foreign currency reserves. Reserves held by the central bank dropped by $728 million to $11.3 billion by April 1, compared with $16.2bn on March 4.

The bank said the decline had largely been due to debt repayments and government payments pertaining to the settlement of an arbitration award related to a mining project.

Some of the decline was expected to be reversed as creditors renew loans, the SBP said, assuring that the country’s external financing needs in the ongoing fiscal year (FY22) were fully met from identified sources.

It said average inflation forecasts had been revised upwards to slightly above 11pc in FY22.

“The SBP is in the process of taking further actions to reduce pressures on inflation and the current account, namely an increase in the interest rate on the export refinance scheme and widening the set of import items subject to cash margin requirements,” the bank said, adding that these items mostly included finished goods and excluded raw materials.

“The announcement of these measures is expected soon and will complement the action taken by the MPC on interest rates today,” it said.

“Though we revised upward our inflation forecast few months back looking at global commodity prices, the SBP has now revised its inflation estimate for FY22,” said Mohammad Sohail, CEO of Topline Securities.

“This step of SBP was also necessary as market yields of T-bills were not in line with policy rate, creating an abnormal situation,” he said.

Fahad Rauf of Ismail Iqbal Securities said, “The SBP has not included any forward guidance in this policy statement. However, this action is likely to be decisive. The real rates on a forward-looking basis are positive for the first time in two years. The SBP is not planning to take any more actions.”

Published in Dawn, April 8th, 2022