State Bank of Pakistan raises policy rate to 15%

State Bank of Pakistan (SBP) in its Monetary Policy Statement (MPS) has increased policy rate by 125bps to 13-year high of 15%.

As per SBP, inflation expectations have risen significantly due to local and international challenges. Inflation in June 2022 rose to a 14-year high of 21.3% as government removed energy subsidies.

Furthermore, external account concerns also increased as current account deficit was reported at US$1.4 billion in May 2022 which was higher than expected. As a result, foreign exchange reserves and rupee has remained under pressure further increasing inflation expectation.

SBP stressed the importance of monetary tightening and its impact on containing aggregate demand. Had the monetary tightening measures not been taken by the central bank, inflationary pressures and external account issues could have further worsened.

SBP also stressed the need to provide targeted subsidies where inflationary pressures and impact of higher utility prices must be absorbed by well-off segment of the society.  

The interest rates on LTFF and EFF 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 500bps relative to the policy rate as per SBP. It is believe that the hike was in line with IMF’s key demand to reduce concessions given to industry and improve monetary policy transmission.    

SBP expects inflation to remain in the range of 18-20% in FY23. It is anticipated to fall in the range of the 5-7% target range by the end of FY24, driven by tight policies, normalization of global commodity prices, and beneficial base effects. GDP growth rate is likely to remain in range of 3-4% in FY23. SBP anticipates Current Account Deficit at 3% of GDP in FY23. 

Despite the impact of tight fiscal and monetary policy 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 reversal of fuel and electricity subsidies.

SBP is likely to continue to monitor developments and factors affecting medium term prospects for inflation, fiscal stability and growth. SBP is anticipated to take appropriate action to safeguard them.

SBP expects Pakistan to reach Staff Level agreement with IMF very soon as government has already taken the difficult decisions like reversal of petroleum subsidies and passage of budget in line with key objectives agreed with IMF.

Completion of the on-going IMF review will also catalyze additional funding which should help Pakistan meeting its external financing requirements. 

Both monetary and fiscal policies are now moving in same direction which should help address inflationary pressures going forward.

SBP has refrained from giving forward guidance recently due to a lot of uncertainty as SBP’s policy decisions will remain data driven.

Though, inflationary pressures are cost push in nature but monetary tightening helps contain core inflation which is also rising and needs to be contained as per SBP.