Mettis Global News
Mettis Global News
Mettis Global News
Mettis Global News

Trending :

Overall demand side inflationary pressures remain contained due to negative output gap: SBP

Share on facebook
Share on twitter
Share on linkedin
Share on whatsapp

January 7, 2021 (MLN): With improving demand indicators and no change in the inflation forecast, SBP kept the policy rate unchanged at 7 percent during Q1-FY21. Continuation of the accommodative monetary stance was deemed appropriate to provide necessary support to the ongoing economic recovery while keeping inflation expectations well-anchored and maintaining financial stability.

According to a quarterly report issued by the State Bank of Pakistan, the economy entered FY21 with some lingering damaging impacts of the Covid pandemic as growth slipped into negative territory in FY20. However, timely measures taken by the SBP and the government, including a host of refinance schemes and concessionary packages, to mitigate the impacts of the Covid shock, prevented the economy from plunging into a deeper recession.

In addition to this, frequent meetings of the Monetary Policy Committee (MPC) were held in the second half of FY20 to closely monitor the evolving situation and take necessary policy measures. With relatively benign inflationary projections compared to last year, the MPC decided to cut policy rate by a cumulative 625 bps during Mar-Jun FY20.

During the first quarter of FY21, the accommodative environment continued: real interest rates remained slightly negative and the availability of concessionary refinance schemes lowered funding costs for businesses and for the households.

Despite this, the downward trend in the growth of overall private sector credit persisted during Q1-FY21 mainly on account of significant retirements in working capital loans. The liquidity cushion available with the firms on the back of sales tax refunds by the government, debt relief measures (loan deferment and restructuring), availability of surplus carry-over stocks and muted input costs helped businesses in retiring their short-term loans.

Notwithstanding signs of recovery in the first quarter of FY21, overall demand side inflationary pressures remain contained due to negative output gap. However, upward risks to inflation persist due to supply side factors. During Q1-FY21, core inflation stabilized but spikes in food prices were recorded in the months of July and September (on month-on-month basis) and, hence, in the overall average of the quarter.

Headline inflation remained low (8.8 percent) as compared to the same period last year (10.1 percent) but was slightly higher than the level observed in the previous quarter (8.4 percent). Meanwhile, the inflation range projected for FY21 was kept unchanged at 7-9 percent as announced in May 2020, with broadly balanced risks. The upside risks included increase in food prices and potential tariff revisions whereas the downward risks included a protracted second wave of the pandemic.

The economic activity resumed with the removal of lockdown: large-scale manufacturing (LSM) displayed an expansion by the time of the monetary policy meeting in September 2020 after witnessing a deep contraction during Q4-FY20. High frequency demand indicators including auto sales, cement dispatches, POL sales, and electricity consumption also indicated recovery Therefore, in its meeting held in September 2020, the MPC decided to keep the policy rate unchanged at the level of 7 percent. This decision was taken in order to keep the monetary conditions accommodative given uncertainty over the growth trajectory and a slight upward revision to the inflation outlook.

The growth of broad money accelerated to 1.2 percent during Q1-FY21 compared to a growth of 0.6 percent during the same period last year. This expansion was the result of a sharp increase in the NFA of the banking system – similar to the trend observed in Q1-FY20 – reflecting an overall improvement in the country’s balance of payments position. There was an increase in the NFA of both the scheduled banks as well as the SBP, the expansion in the former being higher compared to the latter.

In case of the scheduled banks, the turnaround in the current account balance not only helped consolidate nostro balances, but was also instrumental in bringing down foreign liabilities. In case of the SBP, the increase in the NFA was primarily driven by a fall in the foreign liabilities alongside bilateral inflows from China.

With an overall higher deficit during Q1- FY21, financing from the banking system (on accrual basis) increased to Rs 285.2 billion compared to Rs 156.0 billion during Q1- FY20. It is important to recall here that during same period last year, the government made sizable retirements to the SBP while financing these outlays and additional borrowing requirements from the commercial banks.

In contrast, in the absence of voluminous retirements to the SBP during Q1-FY21, borrowings from the scheduled banks remained significantly lower compared to last year. In addition, the government’s adherence for zero borrowings from the central bank continued; the outstanding position of securities held by the SBP remained on a decreasing trend that began at the start of previous fiscal year. During Q1-FY21, the government retired Rs 285.0 billion worth of securities held by the SBP, while mobilizing Rs 567.1 billion from the scheduled banks.

During Q1-FY21, the government set a gross pre-auction target of Rs 3,200.0 billion against the maturities of Rs 2,805.2 billion (of which more than 96 percent were T-bill maturities). However, given the government’s inclination towards raising debt through long term papers, the preauction target for T-bills was set at Rs 903.8 billion lower than the maturities due during the quarter. Instead, the government leveraged on the floating rate PIBs (PFL) that not only offer a longer maturity period but also provide a flexible return in line with the interest rate cycle.

Around 55 percent of the target for new issuances (on net-of-maturity basis) was concentrated in the floating rate PIBs of various tenors. To put this in perspective, the pre-auction target for PFL during Q1-FY21 was set at Rs 830 billion versus a full year target for PFL of Rs 850 billion in FY20.

In the backdrop of multiple rate cuts in the aftermath of the Covid shock, short term yields continued to decline initially. However, from mid-July onwards, as inflation expectations started to increase, the short-term yields began to inch up. This trend got further support from the decision of not holding the July 2020 MPC meeting.

In contrast, the medium to long term yields had already started to rebound in May 2020. The long-end of the yield curve got further traction in July 2020 mainly on the back of the rising inflation expectations. This behavior may also reflect increased optimism of a rapid economic recovery as incidence of new daily Covid cases declined in the country. As a result, the market preferred investing in T-bills (particularly in 3M) and in medium-term floating rate PIBs (PFL). In case of T bills, though the cumulative offers received during the quarter were nearly three times higher compared to the target, the government largely adhered to its auction plan. Therefore, T-bill issuance dropped to Rs 2,047.3 billion compared to Rs 6,482.7 billion during same period last year.

An encouraging growth in the bank deposits together with higher retirements from the private sector, PSEs, and the government commodity procurement agencies helped in easing out liquidity requirements of commercial banks. Cumulatively, these inflows more than offset the liquidity requirement to meet government borrowings needs. Therefore, the average outstanding OMOs fell slightly to Rs 1,014.7 billion compared to Rs 1,192.4 billion in the preceding quarter and Rs 1,337.7 billion in the same period last year.

However, the interbank market remained relatively more volatile during Q1-FY21. In the month of July 2020, the deviation of overnight rates from the policy rate remained highest at 17 basis points, on average, above the policy rate compared to a deviation of 3 and -4 basis points in August and September 2020 respectively. Rates remained on the higher side intially during Q1-FY21 due to more than expected cash withdrawls in July. From mid-August onwards, deposit mobilization picked up pace, which resuted in downward pressure on the overnight rates. This underlying uncertainty in the cash inflows and outflows of the banking system translated in to higher volatity in the overnight rates. Finally, on multiple instances the SBP either completely refrained from intervening in the market to let the market settle on its own or made interventions of lower volumes than was demanded by the market, which also led to heightened volatility in the overnight rates.

State Bank of Pakistan

Posted on: 2021-01-07T11:43:00+05:00

39036