SBP keeps policy rate unchanged at 15%

October 10, 2022 (MLN): The State Bank of Pakistan (SBP) Monetary Policy Committee (MPC) on Monday decided to keep the policy rate unchanged at 15% in line with market expectations, a press release showed.

"At today’s meeting, the Monetary Policy Committee (MPC) decided to maintain the policy rate at 15%," the press release noted.

The MPC noted the continued deceleration in economic activity as well as the decline in headline inflation and the current account deficit since the last meeting. It also noted that the recent floods have altered the macroeconomic outlook and a fuller assessment of their impact is underway. Based on currently available information, the MPC was of the view that the existing monetary policy stance strikes an appropriate balance between managing inflation and maintaining growth in the wake of the floods. On the one hand, inflation could be higher and more persistent due to the supply shock to food prices, and it is important to ensure that this additional impetus does not spillover into broader prices in the economy. On the other, growth prospects have weakened, which should reduce demand-side pressures and suppress underlying inflation. In light of these offsetting considerations, the MPC considered it prudent to leave monetary policy settings unchanged at this stage.

Since the last meeting, the MPC noted several key developments. First, the desired moderation in economic activity has become more visible and entrenched, signaling that the tightening measures implemented over the last year are gaining traction. With growth likely to slow further in the aftermath of the floods, this tightening will need to be carefully calibrated going forward. Second, after peaking in August as expected, headline inflation fell last month due to an administrative cut in electricity prices. However, core inflation continued to drift upwards in both rural and urban areas. Third, the current account and trade deficits narrowed significantly in August and September, respectively, and the Rupee has recouped some of its losses following the recent depreciation. Fourth, the combined 7th and 8th review under the on-going IMF program was successfully completed on August 29th, releasing a tranche of $1.2 billion.

Monetary and Inflation Outlook 

The MPC noted that after peaking in August, headline inflation fell by more than 400bps in September to 23.2%YoY, driven by a reduction in electricity prices due to an administrative intervention. At the same time, the momentum of inflation also slowed by more than expected, declining by 1.2%MoM . On the other hand, both core and food inflation picked up further.The core inflaiton is slighlty above the SBP's policy rate.

Looking ahead, the supply-shock to food prices from the floods is expected to put additional pressure on headline inflation in the coming months. Nevertheless, headline inflation is still projected to gradually decline through the rest of the fiscal year, particularly in the second half. Thereafter, it should fall towards the upper range of the 5-7 percent mediumterm target by the end of FY24. A continuation of prudent monetary policy and orderly movements in the Rupee should help contain core inflation going forward. At the same time, curbing food inflation through administrative measures to resolve supply-chain bottlenecks and any necessary imports should be a high priority.

The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth.

On Floods

The SBP said that with growth likely to slow further in the aftermath of the floods, this tightening will need to be carefully calibrated going forward. While disucssing the post-flood outlook, the MPC noted that the impact of flood related projections are still preliminary and would become firmer after the flood damage assessment being conducted by the government is finalized. Based on currently available information, GDP growth could fall to around 2% in FY23, compared to the previous forecast of 3-4% before the floods.

On real sector, the MPC noted that the recent floods are likely to adversely affect the output of cotton and rice as well as the livestock sector this year.

On the external front, the SBP expects floods to result in greater need for some agricultural imports such as cotton and a few perishable food items. At the same time, exports of rice and textiles are likely to be negatively affected. However, these adverse impacts could to a large extent be offset by downward pressures on the import bill from lower domestic growth and falling global commodity prices and shipping costs. However, given secured external financing and additional commitments in the wake of the floods, FX reserves should improve through the course of the year.

On the fiscal front, the SBP noted that the floods could make it challenging to achieve the planned fiscal consolidation this year, the government has so far been able to meet urgent spending needs through re-allocation and re-appropriations of budgeted funds. Looking ahead, additional foreign inflows, including in the form of grants, should help fund any fiscal slippages. Beyond the current year, reconstruction and rehabilitation will necessitate additional spending over the medium-term, with assistance from the international community.

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