MPS Review: Playing safe

November 24, 2020 (MLN): State Bank of Pakistan (SBP), in its bi-monthly monetary policy of 2020 on Monday, kept its policy rate at 7 percent and stance unchanged, in-line with broad consensus, as it believes that inflationary outlook remains unchanged despite supply-side outruns.

In the latest MPC communication, recent concerns related to an increase in inflation were comprehensively addressed where the SBP expects inflation to remain “well-anchored”, with a given range of 7.0-9.0% YoY in FY21.  Inflationary pressures are expected to wane, going forward, with indications visible in recent SPI readings, favorable base effects, and low core inflation.

The decision also exhibits MPC’s view regarding several high-frequency indicators point to GDP growth of better than 2% earlier expected for FY21, showing a notable improvement in business confidence. Not only this, but SBP also considered burgeoning risks around the second wave of Covid-19 pandemic, both globally and domestically.

On the external front, the committee noted the marked improvement, with CA recording a surplus of US$1.5bn in 4MFY21 (vs. a deficit of US$1.4bn in SPLY) mainly backed by the workers’ remittances and trade balances. Considering higher machinery and food imports in 2HFY21, the MPC now forecasts the CAD to be below 2% of GDP with external funding needs for FY21 being more than adequately taken care of. Also, the SBP mentioned that the healthy improvement in its forex reserves – from US$10.8bn in March to US$12.9bn, the highest level since February 2018– was due to high-quality reasons (not due to additional debt).

This entire situation has induced SBP to avoid any policy acrobatics and play safe by keeping the policy rate constant.

During the analyst meeting, the important takeaway was an update on the resumption of the IMF program. The governor highlighted those technical discussions with the IMF are ongoing and major progress has been made on key sticking points such as electricity tariffs, taxation, etc.; the timing of the same remains a key sticking point.

While an early resumption of the program will certainly be a positive development for the external sector, this will have potential bearings on the monetary outlook, particularly in a scenario where the IMF necessitates front-loaded adjustments, as per research by AKD securities.

As SBP has overweighed the pandemic-induced risk factors in the monetary policy over considerable improvement in several macroeconomic indicators, in order to avoid disrupting the momentum, the report by Intermarket Securities believes that only a considerable – but unlikely – slowdown in the outbreak, both globally and domestically, will encourage the central bank to reverse its stance.  Notably, the SBP stated that its decisions will be data-driven and it is open to taking quick actions should the need arise.

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