July 28, 2021 (MLN): Monetary policy committee of the State Bank of Pakistan (SBP) has maintained the policy rate at 7 percent for the seventh consecutive time as it continues to facilitate economic growth and recovery.
The SBP believed that the growth outlook is still uncertain due to the ongoing fourth wave of Covid-19 in the country and the global spread of new variants, justifying a continued emphasis on supporting the recovery through accommodative monetary policy. However, it has indicated that only at the sign of emerging demand-led pressures on inflation or of vulnerabilities in the current account, the central bank will gradually reduce the degree of accommodation.
The decision is consistent with market consensus, where recent T-Bill auctions saw the greatest participation in the 6mth tenure.
To reach another status quo decision, several key developments were noted by the central bank since the last meeting in May-21. The MPC saw a noticeable continued domestic recovery and improved inflation outlook, following the recent decline in food prices and core inflation. It was of the view that inflation is currently well-anchored and it logically doesn’t warrant the use of interest rate just as yet. In addition, consumer and business confidence has reached multi-year highs and inflation expectations have fallen. As a result of these positive developments, the economic growth in the current fiscal year 2021-22 is expected to increase from 3.9 percent to 4-5 percent, mainly due to capacity investments made through the TERF facility and pro-growth budget FY22 presented by the government. However, the key downside risk to growth stems from the resurgence of Covid cases associated with new strains of the virus both globally and domestically, amid still-low vaccination rates.
The SBP also maintained the projected range of inflation of 7-9% for FY22 as it draws comfort from core inflation falling in recent outturns, and that headline inflation is expected to soften more visibly in the latter half of FY22 when the effect of recent power tariff hikes drops out of the base, converging to the 5-7 percent target range over the medium term. Nevertheless, higher-than-expected global commodity prices, an upward adjustment in Petroleum Development Levy (PDL), rise in energy tariffs and fiscal slippages leading to demand-side inflationary pressure remains key upside risks.
The MPC in its statement noted that the current account deficit that widened in the second half of FY21 on the back of the pickup in domestic activity, import payments along with rising commodity prices- is also expected to be sustainable in FY22. The central bank estimates CAD to be around 2-3 percent of GDP in the current fiscal year. The optimism around the external account is driven by the market-based flexible exchange rate and external financing needs of around $20 billion that is expected to be more than fully met in FY22, resulting in a further increase of foreign exchange reserves. To note, Pakistan successfully raised an additional $1 billion through a tap issuance of its Eurobond that fetched $2.5 billion in March.
It is worth highlighting that the country’s reserve buffers are expected to rise by another $2.8 billion through the IMF’s planned new global SDR allocation.
“It is plausible to assume that the policy rate will remain unchanged in the next MPS in September. The SBP will adjust its stance only if the global commodity prices continue to surge (potentially unlikely amid the outbreak of delta variant) or if there are major slippages on the fiscal side in Pakistan. Even in the face of worsening CAD, it will first rely on the exchange rate to act as the initial line of defense,” Muhammad Saad Ali, Head of Research at Intermarket Securities said.
One of the risks highlighted is if the US Fed continues to indicate earlier than expected tightening, where the increased pressure on the PKR amid strengthening USD could be addressed with interest rate hikes. Lastly, the reassurance from SBP is likely to cheer the Pakistan Equity market and reinvigorate cyclical sector stocks, which have been stuck in a lull period since the end-May 2021, he added.
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