In an emergency meeting, the State Bank of Pakistan announced a 250 bps policy rate hike bringing the policy rate to 12.25%.
In the last scheduled Monetary Policy Committee (MPC) meeting, the SBP stated that it was “prepared to meet earlier than the next scheduled MPC meeting in late April, if necessary, to take any needed timely and calibrated action to safeguard external and price stability.”
The MPC is calling the decision to hike policy rates through an emergency meeting as a “strong and proactive policy response.”
This increases forward-looking real interest rates (defined as the policy rate less expected inflation) to mildly positive territory.
The MPC meeting for April is scheduled on Tuesday April 19, 2022. What this suggests is that the SBP is going to use this emergency rate hike as a signal to brace the markets for a tightening cycle and another hike towards the end of April.
Moreover, in order to reduce demand pull inflation, the SBP is planning on using its tightening tools to curb demand and will make an announcement soon to compliment the MPC decision announced. “The MPC also noted that 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 (EFS) and widening the set of import items subject to cash margin requirements. These items are mostly finished goods including luxury items and exclude raw materials,” read the statement.
“The MPC noted that today’s decisive actions, together with a reduction in domestic political uncertainty and prudent fiscal policies, should help ensure that Pakistan’s robust economic recovery from Covid-19 remains sustainable.”
State Bank catching up
On Wednesday, the Market Treasury Bill (MTB) auction hinted towards a need for a policy rate hike as cut off yields rose significantly. The 3 month cut off yield increased by 80bps to 12.8%, 6 month cut off yields by 75% to 13.25%, 12 month cut off yield rose by 60bps to 13.3%. This is important to note as the average spread between the 3 month, 6 month and 12 month MTBs and policy rate used to be 0.61%, 1.04%, and 1.3% respectively but have climbed to 3.05%, 3.50%, and 3.55%.
The SBP received bids of Rs911 billion, however was able to raise Rs680 billion against the target of Rs600 billion. The bid cover ratio clocked in at 1.34x. The highest participation came in the 3 month tenure MTBs as the market is anticipating higher policy rates in the foreseeable future.
Reasons for the surprise hike
The SBP explains that the outlook for inflation has deteriorated and risks to external stability have risen.
“Since the last MPC meeting, the outlook for inflation has deteriorated and risks to external stability have risen. Externally, futures markets suggest that global commodity prices, including oil, are likely to remain elevated for longer and the Federal Reserve is likely to increase interest rates more quickly than previously anticipated, likely leading to a sharper tightening of global financial conditions,” reads the statement.
The MPC also commented on the impact of political uncertainty on the economic climate of Pakistan “heightened domestic political uncertainty contributed to a 5% depreciation in the rupee and a sharp rise in domestic secondary market yields as well as Pakistan’s Eurobond yields and CDS spreads since the last MPC meeting,”
Moreover, reserves have also been declining as a result of payment obligations and the current account deficit.
The inflation forecasts have been revised upwards to slightly above 11% in FY22 by the SBP. The SBP believes that inflation will moderate in FY23.
The SBP however expects the current account deficit is still expected to be around 4% of GDP in FY22. While the non-oil current account balance has continued to improve, the overall current account remains dependent on global commodity prices.
