May 24, 2022 (MLN): Striving to fix the ongoing economic glitch while skipping the forward guidance, the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) has jacked up the policy rate by 150 basis points (bps) to 13.75%, bringing it to nearly a decade high since 2012.
This attempt to capture the deteriorating circumstances is still in the dire need of fiscal consolidation to complement. It will then help moderate demand to a more sustainable pace while keeping inflation expectations anchored.
While commenting on growth, the MPC underlined, “Since the last MPC meeting, provisional estimates suggest that growth in FY22 has been much stronger than expected.”
Meanwhile, external pressures remain elevated and the inflation outlook has deteriorated due to both home-grown and international factors. Domestically, an expansionary fiscal stance this year, exacerbated by the recent energy subsidy package, has fueled demand, and lingering policy uncertainty has compounded pressures on the exchange rate.
Following the hike in the policy rate, the central bank has moved up the markup rate for financing under Export Finance Scheme (EFS) and Long-Term Financing Facility (LTFF) by 2% to 7.5% and 7%, respectively. In the future, the rates of EFS and LTFF will be linked with SBP Policy Rate through a formula so that any change in policy rate is automatic while continuing to remain below the policy rate in order to incentivize exports.
At present, the cash-strapped economy is suffering from rising political temperature which has kept the incumbent government indecisive towards subsidy rollback that has messed up with the overall balance of payment and IMF tranche, resulting in mounting pressure on the exchange rate.
On the IMF front, Murtaza Syed, Acting Governor SBP on Monday hinted that further delay can be expected in the IMF bailout package as he said during a media briefing, “We should not at all view it as a setback if talks stretch a few days or weeks after Doha Mission ends.”
He added that IMF may issue a positive statement after the ongoing round of discussion. At present, both sides are discussing the best possible way to remove energy subsidies without extending any burden on the masses.
He also said that Pakistan is in a comfortable position to meet the external financing requirement for the next five quarters.
On the other hand, the MPC noted that the reversal of fuel and electricity subsidies will likely increase headline inflation temporarily and may remain elevated throughout the next fiscal year.
However, in FY24, inflation is expected to fall to the 5-7% target range subject to fiscal consolidation, moderating growth, normalization of global commodity prices, and beneficial base effects.
“As electricity and fuel subsidies are reversed, inflation is likely to rise temporarily and may remain elevated through FY23 before declining sharply during FY24. This baseline outlook is subject to risks from the path of global commodity prices and the domestic fiscal policy stance,” MPC cited.
The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth.
With regards to the growth outlook, MPC stated that most demand indicators have remained strong since the last MPS, including sales of POL and automobiles, electricity generation, and sales tax on services, and growth in LSM accelerated in March. Both consumer and business confidence have also ticked up.
This is reflected in the estimated GDP growth rate of 5.97% for FY22, outpacing the outlook of a 4.5% growth rate which has turned the output gap positive. This along with an aggressive hike in policy rate would help to moderate demand.
In FY23, the growth is expected to moderate to 3.5-4.5% in FY23 on the back of monetary tightening and assumed fiscal consolidation.
This increases forward-looking real interest rates defined as the policy rate less expected inflation to mildly positive territory.
Meanwhile, private sector credit growth remained robust through April, reflecting strong economic activity and higher input prices which have enhanced the working capital requirements of firms.
The statement further read, “Since the last MPC meeting, secondary market yields, benchmark rates, and cut-off rates in the government’s auctions have risen, particularly at the short end.”
The MPC noted that the market rates should be aligned with the policy rate and in case of any misalignment after this decision, SBP would take appropriate action.
Business community, on the other hand, has reacted strongly against the decision to raise the policy rate by 150 bps and markup rate by 2% on EFF and termed these decisions unfairly. They are of the view that raising interest rates will hurt the export-oriented industries as the cost of production would be increased significantly.
In response to the SBP’s decision, the capital market turned red on Tuesday as the benchmark KS-100 index plunged by around 490 points.
Despite an aggressive hike to stabilize the exchange rate, the panic is still being there in the market as the local unit remained unsuccessful to recover in today’s session against the greenback and lost further by 48 paisa to close the session at PKR 201.41 per USD while in FYTD, it has plummeted by PKR43.78.
Sectors such as cement and textiles will see an adverse impact as their borrowing cost would see a notable jump. Meanwhile, sectors including banks, oil & gas exploration and fertilizer will be net beneficiaries.
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