SBP Surprises Again, Hikes Policy Rate by 50 bps

Monetary Policy Committee of State Bank of Pakistan (SBP) has surprised the business community and general masses again, increasing the policy rates by 50 basis points to 10.75 percent. The new rate will be effective from 1st April 2019 that will also push up interest rates of the banks.

This is the second hike in policy rate in 2019 as 25 basis points were increased in the policy rate previously, which was also considered as an unexpected move.

It is pertinent to mention here that the policy rate was jacked up 425 basis points in 2018 and 75 basis points this year.

Factor Behind MPC’s Decision

The committee took the decision noting that sustainable growth and overall macroeconomic stability requires further policy measures mainly on the front of underlying inflationary pressures continue.

These pressures on headline inflation are explained by adjustments in the administered prices of electricity and gas, a significant increase in perishable food prices, and the continued unfolding impact of exchange rate depreciation.

Average headline CPI inflation reached 6.5 percent in Jul-Feb FY19 compared to 3.8 percent recorded in the same period last year. Meanwhile, YoY CPI inflation has risen considerably to 7.2 percent in January 2019 and a further to 8.2 percent in February 2019 � the highest YoY increase in inflation since June 2014.

Similarly, a deceleration in consumer demand and capital investments, reflected through a cut in development spending and deceleration in credit for fixed investments, indicates a moderation in domestic demand. In this backdrop, the real GDP growth is projected to be around 3.5 percent in FY19.

The fiscal deficit for -FY19 was higher at 2.7 percent of GDP when compared with 2.3 percent for the same period last year. In view of the shortfalls in revenue collections and escalating security-related expenditures, it is most likely that the target for the fiscal deficit in FY19 would be breached.

So far, a significant portion of the fiscal deficit was financed through borrowings from SBP, which if continued, will not only complicate the transmission of monetary policy but also dilute its impact and prolong the ongoing consolidation efforts.

Positive Development

Economic data released since the last Monetary Policy Committee (MPC) meeting in January 2019 indicates that the impact of stabilization measures continues to unfold. In particular, the current account deficit recorded a sizeable contraction during the first two months of 2019, which together with bilateral inflows, helped ease pressures on SBP’s foreign exchange reserves.

The current account deficit narrowed to US$ 8.8 billion in Jul-Feb FY19 compared to a deficit of US$ 11.4 billion during the same period last year � a fall of 22.6 percent. This includes a notable pace of retrenchment of the current account deficit by 59.9 percent during the first two months of 2019 over the same period last year.

This reduction in the external balance was mainly driven by a 29.7 percent decline in the trade deficit in goods and services as well as a strong growth in remittances. The reduction in the trade deficit is in large part driven by import compression. This decline would have been even more pronounced if not for a rise in oil prices.

Exports, in dollar value, during this period remained flat, however in terms of a quantum, there has been a notable improvement. Though still posing a significant challenge in term of its financing, the narrowing of the current account deficit has translated into some stability in the foreign exchange market.

These developments on the external front have improved stability in the financial markets, reduced uncertainty and improved businesses confidence, as reflected in various surveys. Nonetheless, despite narrowing, the current account deficit remains high, fiscal consolidation is slower than anticipated, and core inflation continues to rise.

Source: Pro Pakistan

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