The State Bank of Pakistan (SBP) has raised the key interest rate by 150 basis points, taking it to 13.75%, as it announces the monetary policy on Monday.
This is the highest interest-rate level since 2011 when it stood at 14%.
In a statement, the SBP said that since the last Monetary Policy Committee (MPC) meeting, the provisional estimates suggest that growth in FY22 has been much stronger than expected.
“The MPC decided to raise the policy rate by 150 basis points to 13.75%,” it said on Monday. “This action, together with much needed fiscal consolidation, should help moderate demand to a more sustainable pace while keeping inflation expectations anchored and containing risks to external stability.
“External pressures remain elevated and the inflation outlook has deteriorated due to both home-grown and international factors. Domestically, an expansionary fiscal stance this year, exacerbated by the recent energy subsidy package, has fueled demand and lingering policy uncertainty has compounded pressures on the exchange rate.
“Globally, inflation has intensified due to the Russia-Ukraine conflict and renewed supply disruptions caused by the new Covid wave in China. As a result, almost all central banks across the world are suddenly confronting multi-year high inflation and a challenging outlook.”
The MPC said it was of the view that the interest-rate hike would help to safeguard external and price stability.
“Since the last MPC meeting, secondary market yields, benchmark rates and cut-off rates in the government’s auctions have risen, particularly at the short end. The MPC noted that the market rates should be aligned with the policy rate and in case of any misalignment after today’s policy decision, the SBP would take appropriate action.”
The statement added that headline inflation rose from 12.7% (y/y) in March to 13.4% in April, driven by perishable food items and core inflation.
“The rise in core inflation reflects strong domestic demand and second-round effects of supply shocks,” it said.
The MPC was of the view that as electricity and fuel subsidies are reversed, inflation is likely to rise temporarily and may remain elevated through FY23 before declining sharply during FY24.
“This baseline outlook is subject to risks from the path of global commodity prices and the domestic fiscal policy stance,” it added.
Current account deficit
The statement added that Pakistan’s current account deficit continues to moderate, and in April, it fell to $623 million, less than half the average for the current fiscal year, on the back of lower imports and record remittances.
“Based on PBS data, the trade deficit shrank by 24% relative to its peak last November. These developments are in line with SBP’s projected current account deficit of around 4% of GDP this year.
“Next year, the current account deficit is projected to narrow to around 3% of GDP as import growth continues to slow with moderating demand and the recent measures taken by the government to curtail non-essential imports, while exports and remittances remain resilient.
“This narrowing of the current account deficit together with continued IMF support will ensure that Pakistan’s external financing needs during FY23 are more than fully met, with an almost equal share coming from rollovers by bilateral official creditors, new lending from multilateral creditors, and a combination of bond issuances, FDI and portfolio inflows.”
The SBP said that as a result, excessive pressure on the Rupee should attenuate and SBP’s foreign exchange reserves should resume their previous upward trajectory during the course of the next fiscal year.
The announcement comes on the day when the local currency continued its slide for the 13th consecutive session and slipped to 200.93, down 0.39%, against the US dollar in the inter-bank market.
The MPC’s announcement was a keenly-awaited event given the country’s economic situation.
This is the first MPC announcement after changes in the government and the appointment of Dr Murtaza Syed as acting governor of the SBP.
In the previous announcement, which was made at an emergency meeting on April 7, the MPC had decided to raise the policy rate by 250 basis points, taking it to 12.25% then.
The monetary policy announcement comes at a time when Pakistan battles challenges on multiple fronts including falling foreign exchange reserves, plummeting currency, current account deficit, and expectations of higher inflation in coming months.
Additionally, Islamabad remains engaged in talks with the International Monetary Fund (IMF) over revival of its stalled Extended Fund Facility (EFF), which will not only pave way for the release of a $900-million tranche, but also open doors for funds from other creditors.