KARACHI: The State Bank of Pakistan, in a meeting of the Monetary Policy Committee (MPC) on Monday, maintained the country’s interest rate at 7pc.
The decision was taken in light of the SBP’s view that business confidence and the outlook for growth had improved, but that the forecast for inflation had risen slightly.
This represents the first time since June that the policy rate was not cut. In the space between March 17 and June 25, the SBP cut the policy rate by a whopping 625 basis points, from the relatively high 13.25pc to 7pc.
More specifically, the central bank cut the policy rate by 75 basis points from 13.25pc to 12.5pc on March 17, by a further 150 basis points to 11pc on March 24, by 200 basis points to 9pc on April 16, by 100 basis points to 8pc on May 15, and by 100 basis points to 7pc on June 25.
In explaining its rationale for maintaining the policy rate, the SBP said that financial conditions continued to be accommodative, with real interest rates remaining slightly below zero on a forward-looking basis. Given the decline in Covid-19 cases in Pakistan, easing of lockdowns and stimulus provided by the government and SBP, the “stance of monetary policy remained appropriate to provide needed support to the emerging recovery.”
INFLATION EXPECTATIONS
According to the SBP, average inflation is expected to fall between the previously announced range of 7-9pc for next fiscal year, rather than marginally below, as had previously been believed.
In January 2020, the inflation rate had hit a record 14.56pc, according to data released by the Pakistan Bureau of Statistics (PBS). However, it has been declining since, slowing to 12.4pc in February, 10.24pc in March, 8.5pc in April and then 8.2pc in May. It then jumped to 8.6pc in June, to 9.3pc in July before stabilizing at 8.2pc in August again.
According to the SBP, the forecast for inflation has risen slightly, primarily due to recent supply side shocks to food prices. However, the bank maintained that core inflation has been relatively stable and demand-side risks to inflation remain well-contained.
Still, it highlighted some risks. “On the upside, risks revolve around food prices, especially in the wake of recent flood-related damages and potential locust attacks. On the downside, the main risk stems from a lower-than-expected pickup in domestic activity. On the global front, the future trajectory of oil prices will also have an important bearing on the domestic inflation outlook,” explained the SBP.
PAKISTAN OUTLOOK
The MPC was somewhat uncertain about Pakistan’s growth outlook.
In a statement, the MPC said that growth is projected to recover to slightly above 2pc in fiscal year 2021, after falling to -0.4 percent last year. Much of this growth is expected to be driven by manufacturing-related activity. The MPC also noted that large-scale manufacturing index grew 5pc year-on-year in July, after significant contraction in March and June 20202.
Still, the MPC said that economic recovery remains uneven across industries, with the hospitality and certain services sectors especially lagging, and the level of activity generally still remains below pre-Corona level. The MPC was also concerned about risks such as a potential second wave of Covid-19 domestic infections, a possible sharp increase in infections in the winter months in Pakistan’s major export markets in Europe and the US, and the threat to agriculture from locust attacks.
In comparison, the MPC was more optimistic about Pakistan’s external sector. “Looking ahead, the current account deficit is expected to remain bounded at around 2pc of GDP. This, together with expected private and official flows, should continue to keep Pakistan’s external position stable in FY21,” the MPC said.
The MPC noted that remittances rose to a record monthly high in July, and have crossed $2 billion for the last three months. Low global oil prices and subdued domestic demand also helped to reduce the current account deficit.
This has meant that the SBP’s foreign exchange reserves have returned to their pre-pandemic level of around $12.8 billion. In other words, Pakistan’s reserve adequacy is now back above the important global benchmark of three months of import cover.
The MPC also noted that the increase in public debt was contained to around 1pc of GDP.
“This largely reflects the strong steps taken by the government to ensure a primary surplus in the first nine months of FY20, which helped provide fiscal space to respond to the Coronavirus outbreak,” the MPC explained.
Tax revenue has averaged 1.2pc growth year-on-year in the first two months of fiscal year 2021, while federal PSDP-related outlays almost doubled during July to August 2020, compared to the same period last year.
“While far below pre-pandemic growth rates, this recovery in tax collections represents an encouraging turnaround from the double-digit reduction observed during the last quarter of FY20,” the MPC said.
SBP MEASURES
In the press conference held on Monday, the MPC made an effort to highlight the SBP’s own series of five targeted measures, which the bank said had helped to inject liquidity.
Together, the measures injected an estimated stimulus of Rs1.58 trillion, or about 3.8pc of GDP, in the cash flow of businesses and households.
The SBP came to this conclusion by dividing up the impact in the following manner: by reducing interest rates, the SBP passed on interest rate benefit to individuals and businesses amounting to Rs 470 billion, which is 1.1pc of GDP. Loans worth Rs650 billion were deferred, amounting to 1.6pc of the GDP, while loans worth Rs184 billion were rescheduled, which is worth 0.4pc of the GDP. The layoff prevention scheme brought a benefit of Rs207 billion or 0.5pc of the GDP, while the scheme supporting hospitals and new investment positively contributed Rs69 billion, or 0.2pc of GDP.
ANALYSTS’ REACTIONS
The decision is in line with analyst expectations. Previously, the CFA Society Pakistan released an MPS survey suggesting that 91pc of research analysts had said that the SBP will not change the interest rates, However, 9pc said that interest rates will further decline by 25 to 50 basis points to 6.75 per cent or 6.5 per cent subsequently.
“Inflation rate in August fell on a year-on-year basis and there is a chance of it falling more,” Intermarket Securities Director Research Raza Jafri said, adding that “Because of the uncertainty about the inflation rate, the SBP most probably would keep the interest rate constant.”
Former Pakistan Stock Exchange Research Officer Muhammad Munir said, “KSE-100, the benchmark rate of PSX, has also risen by almost 5,000 points since the last two months and the government would not want to slow down the market by increasing the interest rate.”
According to Saad Hashmi, Executive Director at BMA Capital, the central bank was expected to maintain the status quo. “This is based on average inflation expectations of around 6.5pc-7pc for the current fiscal year.”
“We expect a status quo due to lower inflation expectations in the near term (particularly Jan-20 CPI of 5.5pc),” noted Sateesh Balani, Director of Research at Ismail Iqbal Securities.
Tahir Abbas, head of Research at Arif Habib, said that “monetary policy targets to increase the aggregate demand which still remain subdued due to the outfall of Covid-19 situation.”
