January 23, 2023 (MLN): The State Bank of Pakistan (SBP) will likely hike the policy rate by around 100 basis points (bps) to 17% in today’s Monetary Policy Committee (MPC) meeting to tame inflation, ahead of the revival of the International Monetary Fund (IMF) loan program, as per market consensus.

This move is likely to have an immediate impact on interest rates and borrowing costs for businesses and individuals.

Experts are divided on the decision, with some praising the central bank’s proactive approach to controlling inflation and stabilizing the economy, while others are concerned about the potential impact on borrowing costs and economic growth.

In the last MPC meeting in November 2022, the policy rate was increased by 100bps to 16%, with the aim of containing the impact of elevated domestic inflationary pressure, so as to embark on a path of sustainable recovery.

The reason behind monetary tightening is to tame inflation and to prevent the currency from devaluation. But in Pakistan’s case, the demand has already been subdued due to 900 bps surge in interest rates since September 2021. In the last few months, the economy has had a slowdown in the large-scale manufacturing sector, reporting negative growth of 5.49% in November 2022.

Additionally, imports have also significantly dropped, partly due to the decrease in demand and partly due to administrative measures taken to control it.

Businesses, especially those in the manufacturing sector, are feeling the pinch as borrowing costs increase. This, in turn, has led to a slowdown in production and a decrease in imports.

The decline in imports is also a reflection of the decrease in consumer demand. With interest rates on the rise, people are less inclined to spend, leading to a reduction in demand for imported goods.

At the same time, within the IMF program, the exchange rate can not be stable for a longer period of time. Thus, PKR will have to lose its ground significantly sooner or later.

Considering the same, the upcoming expected hike will only burden the economy and create fiscal imbalances as the government will have to pay more in terms of rising rates.

It is pertinent to mention that the economy is suffering from cost-push inflation as despite increasing policy rates, the headline inflation rate continues to remain in the double digits, mainly due to an uptick in food and energy prices. The average inflation for 1HFY23 clocked in at 25.02% compared to 9.81% in 1HFY22.

The SBP has revised its inflation expectations for FY23 to 21-23% from 18-20% previously and highlighted the same in its latest monetary policy meeting held on Nov 25th, 2022.

While the decision to raise the policy rate is a difficult one, it is important to remember that the SBP’s primary goal is to ensure stability and sustainable growth for the country.

On the back of administrative measures to curb imports and the decrease in international commodity prices, Pakistan’s current account deficit has decreased by 57% to $3.1 billion during the first five months of the financial year 2023. This is a significant improvement compared to the deficit of $7.2bn during the same period last year.

However, despite the decrease in the current account deficit, the Pakistani Rupee (PKR) continues to face pressure. This is primarily due to the depletion of reserves which have decreased from $13.9bn in July 2022 to $10.44bn to date in a period of six months, due to external repayments. As a result, PKR has depreciated by Rs24.81 or 10.81% against the greenback since the beginning of FY23.

The State Bank of Pakistan (SBP) believes that the external financing needs of Pakistan will be met by rollovers from bilateral official creditors, new lending from multilateral creditors, and a combination of other inflows in FY23.

This should help ease pressure on the rupee and increase the SBP’s foreign exchange reserves, which currently stand at $4.6bn till January 13, 2023.

Based on the above scenarios, all of the leading brokerage houses expect SBP’s monetary policy committee to increase the interest rate by 100%.

While the central bank’s actions are aimed at controlling inflation, it’s important to consider the impact on the broader economy. As the large-scale manufacturing sector and imports continue to decline, it could lead to job losses and slow down economic growth.

It remains to be seen how the monetary tightening will play out in the long term, but for now, the economy is enduring the effects of the interest rate hike.

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Posted on: 2023-01-23T13:56:43+05:00