MPS Review: Holding the reins

September 21, 2021 (MLN): Dr. Reza Baqir, Governor State Bank of Pakistan yesterday has delivered a hawkish surprise with a rate hike of 25bps to 7.25% in a monetary policy committee (MPC) meeting held on Sept 20, 2021, after the Pakistani rupee (PKR) hit a series of low records against the greenback over the last month amid rising current account deficit (CAD).

In a survey conducted by Mettis Global, 38% market participants expected a hike in policy rate while 62% were not expecting any shock.

After keeping it 18 months, the committee resumed tightening as the external account was the main driving force behind this decision, where SBP may revisit its CAD forecast of 2-3% of GDP.

The current account deficit rose to $0.8 billion in July and $1.5 billion in August, reflecting both vigorous domestic demand and high global commodity prices. The growth in exports was reasonably well, averaging $2.3 billion per month in FY22 but they were outstripped by imports, resulting in bearing down on the rupee.

“The urgency & timing of rate hike needs to be watched carefully. If action is taken due to worsening of CAD & faster growth and accommodation stays, it suggests an expansion of money supply that will push CAD in 3-4% range, it’s inflationary and more pressure on the rupee,” Asad Rizvi, Former Treasury Head-Chase Manhattan Bank, said on Twitter.

The central bank believed that the pace of domestic economic recovery has grown much faster than expected.

With growing signs that the latest Covid wave in Pakistan remains contained due to continued progress in vaccination couple overall deft management of the pandemic by the Government, the economic recovery now appears less vulnerable to pandemic-related uncertainty. The committee put a great emphasis on the gradual transition from prioritizing growth to ensuring sustainability. Although inflation remains contained, vigorous domestic growth coupled with multi-year high international commodity prices are expected to stress the current account.

Meanwhile, the SBP’s policy stance of the current still remains supportive of growth through accommodative monetary policy while possible roll-back in stimulus to achieve mildly positive interest rates over time would not be ruled out pursuant to the strength of demand growth, fiscal and external factors.

Expressing his views on MPS, Muzzammil Aslam, Economist said through his social media handle, “SBP has maintained its credibility and followed its forward guidance provided in the past policies through minutely adjusted rates upward.  Furthermore, SBP's future guidance narrates; the economy back to its potential growth trend, time to sustain growth than follow greed.”

The proactive action taken by Dr. Reza Baqir and his team to curb dwindling CAB concerns showed SBP’s independence, regardless of political pressure before it gets uncontrollable.

Deputy Governor, Murtaza Syed in an open floor discussion after the announcement said that the economy is being managed much better this time around due to the flexible market-based exchange rate regime since its introduction in June 2019, including through the Covid shock.  The healthy FX reserves despite falling rupee against the USD, create a buffer to the country’s external position.

The transition to a market-determined exchange rate was a good move to make it the first line of defense. Recent depreciation amidst mounting imports pressure showed that the exchange rate was doing its job. However, policy support seemed necessary to arrest further depreciation. The gradual improvement in net FX reserves is being reflected in the overall lower depreciation of PKR against other frontier/emerging market economies as well, Faizan Ahmed, Head of Research at BMA Capital Management Ltd.

“Some well-deserved credit to SBP from foreign selling aside today. Predictability and rational behavior are key. CAD goes up, PKR down, not reserves,” Mattias Martinsson, Founder and Chief Investment Officer at Tundra Fonder tweeted. The economy started recovering from CY19; rates normalize. Macroeconomists in Frontier Markets have a new favorite, he noted.  

Shedding light on Afghanistan’s situation, the MPC noted that it’s premature to decipher the extent of implications on Pakistan’s economy. The bank is continuously monitoring the foreign exchange market, cash market and money changers in the formal and informal sectors and the border areas with the help of FBR.

On IMF, the central bank highlighted that progress is ongoing to achieve positive outcomes in the upcoming review wherein the use of IMF’s SDR allocation is open to negotiations and can be used for both balances of payments and fiscal purposes as well.

The increase in policy rate is likely to be a non-event for the market where subsidized schemes have already diluted the impact of changes in the interest rate on profitability. However, it has opened up expectations of future rate hikes which could bring back long-gone interest in banks given their higher exposure to lending arrangements, Hamza Kamal, Research Analyst at AKD securities said.

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Posted on: 2021-09-21T17:05:08+05:00