September 13, 2023 (MLN): The State Bank of Pakistan (SBP) will likely hike the policy rate by 100 basis points (bps) to 23% in tomorrow’s Monetary Policy Committee (MPC) meeting to tame the uncontrollably high inflation.

The expectations of a sharp hike in policy rate stem from a deteriorating outlook for inflation due to the surge in global commodities prices, which is beginning to reshape inflation expectations.

Adding fuel to the fire, Pakistan's heavy reliance on imported oil exposes it to the escalating global oil prices observed in recent months, further intensifying the inflationary pressure.

Brent Crude, which is the benchmark for oil prices, has risen by 8.64% since the last monetary policy statement (MPS), reaching $92.57, the highest since November 2022.

Domestic petrol prices have witnessed a substantial increase of 16.55% since the last MPS.

This will also have an impact on other consumer price index (CPI) basket items, such as food, which will also be affected by higher transportation costs, creating a ripple effect.

Given that Pakistan is a net importer, its CPI basket is also sensitive to Pakistani Rupee (PKR) fluctuations.

To note, the inflation in the first two months of FY24 has averaged around 27.8%, which is one of the highest in Asia.

In the last six months, inflation has continued to rise, in part due to rising food prices and the passthrough from the local currency’s depreciation.

The International Monetary Fund (IMF) in its staff report highlighted the failure of SBP in forecasting inflation trends and its delayed response to rising prices.

The report said that the SBP stopped policy rate hikes prematurely, hoping that inflation had reached its peak and would soon decline, this inconsistent monetary policy also had a negative impact on the economy.

“Despite the mounting pressures, actions by the SBP lacked clarity, as it kept its policy rate unchanged in Monetary Policy Committee meetings in August, October, and early June, expecting that the price rises had peaked and would subside, but hiked rates in November, March, April, and late June” it noted.

Experts are in consensus on the rate hike, this expectation was reinforced by the latest T-bills auction held on September 07, which witnessed a sharp increase in the cut-off yields, reaching 24.5%, 24.787%, and 25.0687% for 3, 6, and 12 months respectively.

This means that the cut-off yields showed a rise of 162bps for 3 months and 213bps for 12 months as compared to the last auction held on August 23.

This indicates that the market has already priced in the interest rate hike for this meeting.

At this point, none of the experts expect a dovish stance.

To recall, in the last MPC meeting on July 31, the SBP decided to maintain the policy rate at 22% as the Central Bank anticipated the headline inflation to ease on the back of the high base effect.

It is important to note that Pakistan is currently experiencing one of the most intense and aggressive rate hike cycles in over three decades.

In just 21 months, the SBP has hiked rates by a whopping 1,500 basis points, from 7% in August 2021 to 22% in July 2023, making it a period of monetary tightening unlike any other in recent history.

Meanwhile, according to the latest poll conducted by Mettis Link News, market participants are largely expecting a 200-300bps rate hike.

PKR: SBP Reforms and Crackdown Efforts

Since the last MPC meeting, the PKR has depreciated by 2.77% in interbank and by 4.15% in the open market against the US Dollar.

Moreover, the gap between the exchange rates of the interbank and open market has exceeded the IMF's 1.25% threshold during 23 out of the last 31 trading sessions, which accounts for 74.19% of the total sessions since the last MPC meeting.

Meanwhile, it has surpassed this 1.25% limit in 74 out of the total 166 (44.58%) trading sessions in the current calendar year.

However, it is pertinent to note that amidst all the uncertainty and chaos within the nation, the recent steps taken by the SBP have had a beneficial impact on the local currency and have effectively curbed its continuous depreciation to some extent.

SBP has introduced reforms aiming to consolidate and transform various types of exchange companies into a single category with a well-defined mandate and higher capital requirements.

These reforms also encourage leading banks to establish wholly owned exchange companies to cater to the legitimate foreign exchange needs of the general public.

In addition, the minimum capital requirement for ECs has been increased from Rs200 million to Rs500 million.

Moreover, commercial banks will be setting up new arms of exchange companies to facilitate the public at large. 

On top of this, the ongoing crackdown against speculators, hoarders, and smugglers has also played a crucial role in stabilizing the PKR.

Consequently, the gap between the open market and interbank has narrowed considerably, falling below the International Monetary Fund's (IMF) recommended level of 1.25% in recent weeks, which had surged to above 8% earlier in the month.

Besides the interbank and Kerb markets, the black market for Hawala/Hundi is also experiencing a significant decline in dollar rates.

Depleting Foreign Exchange reserves

The latest total liquid foreign reserves position showed $13.13 billion held by the country, while the reserves held by the SBP stood at $7.78bn.

To note, since the Staff Level Agreement (SLA) was signed with the International Monetary Fund (IMF), the total liquid foreign reserves held by the country got a substantial boost worth $4.2bn, from the IMF and Arab countries.

Consequently, in the current fiscal year, total liquid foreign reserves have increased by $3.95bn or 42.97%.

However, ever since the boost from the IMF and the Arab countries, fresh inflows seem to have dried up, with the total reserves slowly depleting almost every week.

Copyright Mettis Link News

Posted on: 2023-09-13T16:12:19+05:00