Karachi, July 07, 2022 (PPI-OT):1. At today’s meeting, the Monetary Policy Committee (MPC) decided to raise the policy rate by 125 basis points to 15 percent.
In addition, as foreshadowed in the last monetary policy statement, the interest rates on EFS and LTFF loans are now being linked to the policy rate to strengthen monetary policy transmission, while continuing to incentivize exports by presently offering a discount of 500 basis points relative to the policy rate.
This combined action continues the monetary tightening underway since last September, which is aimed at ensuring a soft landing of the economy amid an exceptionally challenging and uncertain global environment. It should help cool economic activity, prevent a de-anchoring of inflation expectations and provide support to the Rupee in the wake of multi-year high inflation and record imports.
2. Since the last meeting, the MPC noted three encouraging developments. First, the unsustainable energy subsidy package was reversed and an FY23 budget centered on strong fiscal consolidation was passed.
This has paved the way for completion of the on-going review of the IMF program, which will ensure that tail risks associated with meeting Pakistan’s external financing needs are averted. Second, a $2.3 billion commercial loan from China helped provide support to FX reserves, which had been falling since January due to current account pressures, external debt repayments and paucity of fresh foreign inflows.
Third, economic activity remains robust, with the momentum of the last two years of near 6 percent growth carrying into the start of FY23. As a result, Pakistan faces a significantly lower trade-off between growth and inflation than many countries where the post-Covid recovery has not been as vigorous.
3. However, several adverse developments have overshadowed this positive news. Globally, inflation is at multi-decade highs in most countries and central banks are responding aggressively, leading to depreciation pressure on most emerging market currencies.
This strong monetary tightening has occurred despite concerns about a slowdown in global growth and even recession risks, highlighting the primacy that central banks are placing on containing inflation at this juncture.
Domestically, as energy subsidies were reversed, both headline and core inflation increased significantly in June, rising to a 14-year high. Inflation expectations of consumers and businesses also rose markedly. At the same time, the current account deficit unexpectedly spiked in May and the trade deficit continued its post-March widening trend to reach a 7-month high in June, on burgeoning energy imports. As a result, FX reserves and the Rupee remained under pressure, further worsening the inflation outlook.
4. Against this challenging backdrop, the MPC noted the importance of strong, timely and credible policy actions to moderate domestic demand, prevent a compounding of inflationary pressures and reduce risks to external stability.
Like most of the world, Pakistan is facing a large negative income shock from high inflation and necessary but difficult increases in utility prices and taxes. Without decisive macroeconomic adjustments, there is a significant risk of substantially worse outcomes that would compromise price stability, financial stability and growth.
This could take the form of runaway inflation, FX reserve depletion and the need for sudden and aggressive tightening actions later that would be significantly more disruptive for economic activity and employment. Adjustment is difficult but necessary in Pakistan, as it is all over the world.
However, in the interest of social stability, the burden of this adjustment must be shared equitably across the population, by ensuring that the relatively well-off absorb most of the increase in utility prices and taxes while well-targeted and adequate assistance is provided to the more vulnerable.
Sustainability amid high gross financing needs due to the relatively short maturity of Pakistan’s domestic debt.
It is critical that the envisaged fiscal consolidation is delivered. It would allow monetary and fiscal policy to resume the well-coordinated approach that characterized Pakistan’s successful Covid response in FY20 and FY21, which supported growth while preserving fiscal and external buffers. At the same time, it is important that the new taxation measures are progressive.
In particular, their burden should mainly be absorbed by the relatively better off while adequate protection is provided to the more vulnerable, for whom high food prices are a particular concern. In this context, curbing food inflation through supply-side measures aimed at boosting output and resolving supply-chain bottlenecks should be high priority.
Monetary and inflation outlook
9. In nominal terms, private sector credit grew by a further 2 percent (m/m) in May, driven by favourable developments in sectors like power, edible oil, construction-allied industries, as well as wholesale and retail trade.
Demand for fixed investment and consumer loans also picked up, reflecting robust economic activity. Since the last MPC meeting, secondary market yields and cut-off rates in the government’s auctions have ticked up in the wake of the high inflation reading in June.
10. Headline inflation rose significantly from 13.8 percent (y/y) in May to 21.3 percent in June, the highest since 2008. The increase was broad-based – with energy, food and core inflation all rising significantly and more than 80 percent of the items in the CPI basket experiencing inflation of above 6 percent.
Strong domestic demand and second-round effects of supply shocks are reflected in the rise of core inflation to 11.5 percent in urban areas and 13.5 percent in rural areas. At the same time, measures of both short and long-term inflation expectations continue to tick up. Despite the dampening effect of fiscal and monetary tightening on demand-pull inflation, inflation is likely to remain elevated around current levels for much of FY23 due to the large supply shock associated with the necessary reversal of fuel and electricity subsidies.
As a result, inflation during FY23 is forecast at around 18-20 percent before declining sharply during FY24. This baseline outlook is subject to significant uncertainty, with risks arising from the path of global commodity prices, the domestic fiscal policy stance, and the exchange rate. The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth and will take appropriate action to safeguard them.
For more information, contact:
Chief Spokesman,
State Bank of Pakistan (SBP)
Central Directorate
I.I. Chundrigar Road, Karachi, Pakistan
Tel: +92-21-111-727-111
Tel: +92-21-39212562
Fax: +92-21-39212433 – 39212436
Email: chief.spokesperson@sbp.org.pk
Website: www.sbp.org.pk