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MPS Review: GDP growth revised up to 3% but supply shocks may feed inflation fears

March 22, 2021 (MLN): The State Bank of Pakistan (SBP) on Friday kept the policy rate intact at 7%, in line with the SBP’s guidance in the previous MPS (January 2021) and market consensus. It has remained unchanged since June 2020 when the central bank had reduced the interest rate by 100 bps.

The Monetary Policy Committee (MPC) continued with the accommodative stance as long as it is necessary to recover growth and employment and ensuring further improvement in business sentiments while keeping inflation expectations remain on target.

Even though recent inflation readings have shown a sharp uptrend (8.7% in February 2021 vs 5.7% in January), primarily driven by supply-side factors in major food items and a recent increase in electricity tariffs with the MPC highlighting that the output gap is still negative. That said, core inflation remains in range-bound, and inflation expectations—while drifting up somewhat due to the recent increase in headline inflation numbers—are still well-anchored within the previously projected medium range of 5-7%.

On the fiscal front, the government may continue its contractionary policy in the next federal budget for FY22 so as to reduce public debt and therefore an accommodating monetary policy stance should also provide support. This will only remain likely if second-round effects of the hike in administered prices and other one-off supply shocks do not emerge and CPI remains contained, the report by Arif Habib highlighted.

Encouragingly, SBP has raised its GDP growth forecast for FY21 from 2-2.5% to 3% –driven by 79% YoY growth in LSM in 7MFY21 on the back of the SBP’s temporary refinancing facilities and targeted fiscal support and similar trends in Agriculture. While this is a sharp improvement from the 1% growth expected by the IMF at the start of FY21, the SBP considers 3% to be mild for Pakistan (which has a population growth of 2%), as per key takeaways covered by Intermarket Securities.

In reaching its decision on the policy rate, the MPC also took note of the uncertainty around the inflation and growth outlook. On the growth front, the MPC noted that despite recent momentum, risks remain due to the emergence of a third, more virulent wave of Covid in Pakistan just as the vaccine roll-out is beginning.

On the external front, the current account balance remained in surplus, standing at US$0.9bn in 7MFY21, supported by continuous robust growth in workers’ remittances, relatively subdued domestic demand and a nascent recovery in exports. However, MPC highlighted that with the economic recovery, the trade deficit is widening somewhat on the back of imports of capital goods and industrial materials as well as food, together with rising international commodity prices. Nevertheless, SBP expects the current account deficit in FY21 to remain below 1 percent of GDP given the out-turn to date, continued strong prospects for remittances and high value-added textiles-led exports.

Further, the resumption of the IMF program has ensured external financing needs. These favorable developments and improving sentiment contributed to an additional 3.4 percent appreciation in the PKR since the last MPC meeting while keeping the SBP’s foreign exchange reserves around USD13 billion, levels last seen three years ago.

In terms of the inflation outlook, SBP will closely monitor any potential de-anchoring of inflation expectations given this summer’s wage negotiations, any new tax measures in the next year’s budget and rising international commodity prices amid a recovery in global economies that could continue to feed into domestic inflation.

Continuing with its recent initiative of providing forward guidance, MPC said, ‘In the absence of unforeseen developments, the MPS expects monetary policy settings to remain broadly unchanged in the near term. As the recovery becomes more durable and the economy returns to full capacity, the MPS expects any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates.’

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Posted on: 2021-03-22T19:46:00+05:00

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