April 2, 2019 (MLN): The State Bank of Pakistan culminated the markets’ expectation of a 50 – 75 bps hike in monetary policy, last week, by pushing up the key rate to 10.75% effective from yesterday, April 1, 2019.
The Monetary Policy Committee took into account the sizeable contraction in current account deficit (CAD) during first two months of 2019, and the bilateral inflows which collectively helped ease pressure on the central bank’s foreign reserves.
With an improvement in the external balance as well as an increase in bilateral official inflows, SBP’s foreign exchange reserves gradually recovered to US$ 10.7 billion on 25th March 2019.
However, the committee could not overlook the fact that despite narrowing, the current account deficit remains high, fiscal consolidation is slower than anticipated, and core inflation continues to rise.
Amidst the efforts to curtail inflationary pressures and reduce the otherwise widening macroeconomic imbalances, domestic economic activity experienced the brunt of the stabilization measures implemented thus far.
In particular, Large-scale Manufacturing (LSM) declined by 2.3 percent during Jul-Jan FY19 against 7.2 percent growth recorded in the same period last year.
The slowdown in commodity producing sectors has had downside implications for growth in services sector as well. Similarly, a deceleration in consumer demand and capital investments, reflected through a cut in development spending and deceleration in credit for fixed investments, indicates a moderation in domestic demand.
On the other hand, while the reserves are still below the standard adequacy levels (equal to three months of imports cover), the recent improvement on the external front has nevertheless improved business confidence, which was captured in the recent wave of IBA-SBP survey of a large number of firms in industry and services sector.
Having said that, the Monetary Policy Committee (MPC) believes that the share of private financial flows need to increase on sustainable basis to achieve medium-to-long term stability in the country’s external accounts.
Similarly, concerted structural reforms are required to reduce the trade deficit by improving productivity and competitiveness of the export-oriented sectors, said the Committee.
In addition to this, the fiscal deficit for 1H-FY19 was higher at 2.7 percent of GDP when compared with 2.3 percent for the same period last year.
So far, a significant portion of the fiscal deficit was financed through borrowings from SBP, which if continued, will not only complicate the transmission of monetary policy but also dilute its impact and prolong the ongoing consolidation efforts.
Taking these macroeconomic developments into consideration, the MPC concluded that sustainable growth and overall macroeconomic stability requires further policy measures as underlying inflationary pressures continue, the fiscal deficit is elevated, and despite an improvement, the current account deficit is still high.
Faced with this macroeconomic scenario, the MPC decided to increase the policy rate after detailed deliberations.
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