January 30, 2019 (MLN): In anticipation of the outcomes of Monetary Policy Committee (MPC) meeting that is scheduled to take place tomorrow, brokerage houses in general have unanimously put forth a forecast that the State Bank of Pakistan (SBP) will not take further tightening measures and the key policy rate will remain firm at 10% for the next two months.
However, the Monetary and Fiscal Policies Coordination Board hinted towards yet another fiscal tightening measure when it reviewed the fiscal and monetary policies of the country and observed that there is further scope for tightening of the fiscal stance.
Even if this doesn’t translate into an actual fiscal tightening action, one can deduce from this observation that the Board probably recognizes the need for such a measure.
It is pertinent to note that the government did not introduce any new tax measure in its recent mini-budget announcement and the weekly data on monetary aggregates has shown that the federal government has cumulatively borrowed over Rs.3 trillion from SBP for budgetary support.
These developments should technically lead the way towards higher inflation, which the central bank is aware of and is thus willing to adopt a contractionary measure this time around.
Furthermore, taking lead from previous events, it can be expected that SBP feels the need to employ a contractionary policy, because when it announced its previous Monetary Policy Action, the central bank pointed out that continued inflationary pressure (and rising inflationary expectations) needs to be checked and although narrowing, the current account deficit is still high and the fiscal deficit remains elevated.
With the aforesaid macroeconomic scenario as a backdrop, SBP deemed that further consolidation was required to ensure stability.
The finance ministry on the other hand does not wish to raise the policy rates in near future, considering the potential economic slowdown it will entail.
Nevertheless, there is a common belief within markets 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.
Mr. Arsalan Hanif at Arif Habib Limited (AHL) supported the possibility of this stance and listed down more reasons for SBP to keep the rates unchanged. Among these reasons, he drew attention to the slowdown in inflationary pressure due to decline in petroleum product prices, expected reduction in Current Account Deficit (CAD) due to strict conditions on imports, financial support from UAE and KSA and high real interest rates.
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