February 1, 2019 (MLN): Drawing encouragement from the gradually materializing impact of its previous policy implementations, the Monetary Policy Committee (MPC) raised the policy rate for next two months by another 25 basis points (bps) yesterday, thereby pushing up interest rates to 10.25%.
In its official Monetary Policy statement, MPC affirmed that it has taken into account the implications of economic data released for the last 12 months, and has deduced that the stabilization measures implemented during the period are taking hold.
The committee seemingly wants to reduce domestic consumption and therefore takes signs of deceleration in domestic demand as a positive development. In addition to this, MPC pointed out that the Current Account Deficit (CAD) is narrowing down and an increase in financial inflows are helping in reducing pressure on external accounts.
Building on this economic progress and realizing that the impact of policy implementations are finally kicking in, the general market formed a unanimous opinion that since the central bank has already raised the interest rates heavily during CY18 (425 bps cumulatively), it will now wait for the full impact of that action to materialize before going for another rate hike.
However, while these developments reflect the economy’s movement in a positive direction, challenges still persist: (a) despite narrowing, the current account deficit remains high; (b) fiscal deficit is elevated; and (c) core inflation is persistently high. MPC stated in its statement that this situation calls for continued consolidation efforts.
“Average headline CPI inflation stands at 6.0 percent for the first half of FY19, which is considerably higher than the 3.8 percent recorded during the same period last year.” However, the YoY inflation has shown moderation in the last two months, primarily due to a sharp fall in prices of perishable food items and a downward adjustment in prices of petroleum products.
Going forward, the second round impacts of the exchange rate movements, upward adjustments in gas and electricity tariffs, and higher government borrowings from SBP are likely to be offset by the lagged impact of the increase in policy rates and the fall in international oil prices, on inflation. Accordingly, the MPC’s projected range of inflation remains unchanged at 6.5 to 7.5 percent.
The committee has remarked that the pickup in inflation and the continuation of economic challenges are taking their toll on economic performance. Real economic activity has witnessed a marked slowdown during the first half of the year.
In absolute terms, net budgetary finance from SBP reached Rs 3,770.5 billion during 1st Jul-18th Jan FY19, which is 4.3 times the amount borrowed during the same period last year. This financing will potentially have inflationary consequences in the future.
Moreover, the fiscal deficit for first half FY19 is likely to be higher than the same period last year, estimates MPC. This shows that despite a sharp cut in PSDP releases and rationalization of tariffs and duties, fiscal consolidation remains a challenge.
The MPC noted that the impact of stabilization measures implemented so far is gradually unfolding and confidence is improving amidst reduced economic uncertainty, but identifying these measures as insufficient in light of the aforesaid challenges, the committee opted for further consolidation.
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