SBP Raises The Policy Rate By 100 Bps, To 16%


On Friday, the State Bank of Pakistan unveiled a new monetary policy, which included an increase in the policy rate by 100 basis points, from 14 percent to 16 percent.

Consistent global and domestic supply shocks are rising costs despite the ongoing economic recession. As a result, these shocks are trickling down to broader price and wage levels, which has the potential to unmoor inflation expectations and weaken GDP in the medium run. A statement from the SBP’s Monetary Policy Committee states, “The rise in cost-push inflation cannot be ignored and needs a monetary policy response”

The MPC found that preventing inflation from becoming entrenched would have greater long-term costs than implementing measures to reduce it. It is nevertheless crucial to take administrative action to eliminate bottlenecks in the food supply chain and to bring in any required imports in order to keep food prices low.

The MPC discussed three significant domestic developments since their last meeting. Firstly, headline inflation jumped in October when an earlier month’s administrative decrease to power costs was reversed.

Inflationary pressures have increased as a result of the damage to crops from recent floods, which has led to a sharp increase in the cost of food. Second, the current account deficit narrowed substantially in both September and October as a result of a steep drop in imports.

However, difficulties with foreign accounts continue despite this adjustment and new ADB funding. Third, the FY23 growth predictions and current account deficit projections from the previous monetary policy statement have been re-affirmed after taking into consideration the Post-Disaster Needs Assessment of the floods and ongoing developments. Increases in both food and core inflation are anticipated to raise average inflation for FY23 to 21.5% – 23.5%.

Real Estate Sector

Since the previous MPC meeting, economic activity has remained subdued due to temporary interruptions caused by floods and ongoing policy and administrative actions. Sales of cement, POL, and vehicles were just some of the demand indicators that showed double-digit annual declines in October.

For the sixth straight month, power generation has decreased, this time by 5.2%. The first three months of FY23 saw a stagnation in LSM output compared to the same period last year, with primarily export-oriented industries showing growth. Recent estimates show significant production losses to rice and cotton crops as a result of the floods, which, together with weak expansion in manufacturing and construction, will impact on GDP this year.

External Sector

The gap between imports and exports narrowed to $0.4 billion in September and $0.6 billion in October. Deficit in goods and services traded internationally decreased to $2.8 billion in the first four months of FY23, down by nearly half from the same period previous year.

The decrease in imports across the board by 11.6% to $20.6 billion was the primary factor in this improvement, along with an increase in exports by 2.6% to $9.8 billion. Despite this, remittances decreased by 8.6 percent to $9.9 billion due to the normalisation of travel and the strengthening of the US currency.

Financing-wise, inflows are being hampered by local uncertainties and tightening global financial conditions as major central banks continue to hike policy rates. A net inflow of $1.9 billion was seen in the financial account over the first four months of FY23, down from a net inflow of $5.7 billion for the same period in FY22.

As for the future, the economic downturn and softer global commodity prices should more than counteract the effects of the floods on trade, with increased imports of cotton and decreased exports of rice and textiles.

FX reserves are forecast to rise steadily as planned external inflows from bilateral and multilateral sources materialise, keeping the current account deficit manageable in FY23. It is possible that the pressures on the external account may decrease even further if the current drop in global oil prices continues or if the pace of rate rises by major central banks slows.

Fiscal Sector

Despite the consolidation planned for FY23, fiscal results worsened in Q1 as compared to Q1 of the previous fiscal year. From 0.7 to 1% of GDP, the government’s spending shortfall grew, while the primary surplus shrank to 0.2 percentage points of GDP.

The drop in non-tax receipts and the increase in interest payments were the primary causes of this deterioration. Also, during the first four months of FY23, growth in FBR tax receipts slowed to 16.6 percent, which is more than half the rate seen in FY22. Government mark-up subsidies for farmers and subsidised inputs are only two of the many flood relief initiatives enacted for the agricultural industry.

It is important to minimise slippages by largely meeting additional spending needs through expenditure re-allocation and foreign grants, while limiting transfers to only the most vulnerable, given that the floods may make it difficult to achieve the aggressive fiscal consolidation budgeted for this year.

In order to prevent inflation from becoming entrenched and to reduce external vulnerabilities, monetary tightening must be accompanied with fiscal restraint.

Budgetary and Price Trend Projection

Private sector lending continued to moderate during Q1, growing by just Rs86.2 billion compared to Rs226.4 billion during the same time previous year.

As domestic cotton production fell, working capital loans to wholesale and retail trade services and the textile industry fell sharply, and consumer financing slowed.

Inflation as measured by the Consumer Price Index increased by 3.15 percentage points, to 26.6%, in October, due to higher food and energy costs. The cost of both energy and food has increased by 35 percent. Meanwhile, core inflation rose to 18.2% in rural regions and 14.9% in urban areas as higher food and energy costs rippled across the economy.

Inflation accelerated significantly, increasing by 4.7%. Inflation forecasts for FY23 have been increased in light of these events.

Prudent macroeconomic measures, orderly Rupee movement, stabilising global commodity prices, and helpful base effects are projected to help bring inflation down to the upper range of the 5-7 percent medium-term objective by the end of FY24, albeit this may take longer than initially anticipated.

The MPC will keep a close eye on anything that might impact inflation, financial stability, and economy in the medium run.


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