Pakistan: Takeaways from central bank briefing after 300bps hike in interest rate

The State Bank of Pakistan (SBP) on Thursday increased the benchmark policy rate by 300bps to 20%. It noted that the recent fiscal adjustments (mini-budget) and exchange rate depreciation have significantly deteriorated near-term inflation outlook. The SBP also revised its headline inflation target for FY23 to 27-29%.

It was highlighted that despite the drastic decline in current account deficit (CAD) in 7MFY23, upcoming debt repayments and a decline in financial inflows continue to exert pressure on foreign reserves and the exchange rate.

The recent fiscal adjustments i.e. hike in GST and FED, reduction in subsidies are expected to help contain the otherwise widening fiscal and primary deficits.

It is believed that after the interest rate hike decision, real interest rates have been pushed into positive territory on a forward-looking basis. This will help anchor inflation expectations and steer inflation to the medium-term target of 5 – 7% by end FY25.

The central bank also arranged a briefing and the takeaways are:

Of the US$23 billion in expected principal repayments at the start of FY23, about US$15.8 billion has been settled by: USD$9.8 billion repayments and US$6 billion rolled-over. Remaining US$7.2 Billion includes US$3 billion which is expected to be rolled-over also and US$4.3 billion, of which US$1.3 billion would be re-financed. Hence, US$ 2.9 billion in repayments are required over April-June 2023.

Pakistan has no intention of restructuring Eurobonds as all commitments are expected to be met on time with the next repayment tranche of US$1 billion due next year. Similarly, most of the external debt pertains to bilateral and multilateral borrowing which can be rolled-over. A small portion relates to commercial bank loans and the Government is already in contact with bilateral partners to secure further support.

Overall, inflationary pressures remain high across all groups following recent fiscal adjustments and depreciation of PKR. The rise in core inflation is much sharper compared to the previous episode. In particular, services core inflation (excluding house rent and transportation) has risen more sharply.

Global economic prospects have improved slightly with international commodity prices seem to be peaking. Accordingly, export values have come down. However, import volumes have fallen drastically. Pakistan’s CAD has also improved, but official FX reserves cover is still much below the adequate level. Nevertheless, the reserves position is expected to improve following conclusion of the 9th EFF review.

Demand compression measures include ongoing monetary tightening and fiscal adjustments coupled with PKR depreciation, are bringing down economic growth momentum towards sustainable levels. This is evident from the moderation seen in high frequency growth indictors, broader decline in LSMI and fall in private sector borrowing.

There have been no demands from the IMF to implement a ‘border exchange rate’. However, the IMF has recommended narrowing the difference between the inter-bank and open-market PKR/USD rates.

Current amount of outstanding OMO injections is PKR 6.5 Trillion. Its main objective is to keep short-term interest rates aligned with the policy rate.