Pakistan: Central Bank Reduces Interest Rate

At its meeting on June 10, 2024, the Monetary Policy Committee (MPC) decided to reduce the policy rate by 150 bps to 20.5%, effective from June 11, 2024. The MPC noted that while the significant decline in inflation since February was broadly in line with expectations, the May outturn was better than anticipated earlier. 

The Committee assessed that underlying inflationary pressures are also subsiding amidst tight monetary policy stance, supported by fiscal consolidation. This is reflected by continued moderation in core inflation and ease in inflation expectations of both consumers and businesses in the latest surveys. At the same time, the MPC viewed some upside risks to the near-term inflation outlook associated with the upcoming budgetary measures and uncertainty regarding future energy price adjustments. Notwithstanding these risks and today’s decision, the Committee noted that the cumulative impact of the earlier monetary tightening is expected to keep inflationary pressures in check.

The MPC noted the following key developments since its last meeting. First, real GDP growth remained moderate at 2.4% in FY24 as per provisional data, with subdued recovery in industry and services partially offsetting the strong growth in agriculture. Second, reduction in the current account deficit has helped improve the FX reserves to around US$9 billion despite large debt repayments and weak official inflows. The government has also approached the IMF for an Extended Fund Facility program, which is likely to unlock financial inflows that will help in further build-up of FX buffers. Lastly, international oil prices have declined, whereas non-oil commodity prices have continued to inch up.

Based on these developments, the Committee, on balance, viewed that it is now an appropriate time to reduce the policy rate. The Committee noted that the real interest rate still remains significantly positive, which is important to continue guiding inflation to the medium-term target of 5 – 7 percent. The Committee also emphasized that the future monetary policy decisions will remain data-driven and responsive to evolving developments related to the inflation outlook.

Real Sector

Latest estimates indicate real GDP growth at 2.1% in Q3-FY24 against a contraction of 1.1% in the same quarter last year. While agriculture was already showing strong growth, industry also witnessed positive growth in Q3. Also, initial growth estimates for both Q1 and Q2 for FY24 were revised upward. Taking into account the developments in the first nine months, FY24 growth is provisionally estimated by PBS at 2.4% against a contraction of 0.2% in FY23. Almost two-thirds of this recovery was explained by improvement in the agriculture sector. These developments are in line with the Committee’s earlier expectations. For FY25, the MPC expects economic growth to remain moderate. This assessment takes into account the impact of expected moderation in agriculture output and ongoing stabilization policies.

External Sector

The current account posted a surplus for the third consecutive month in April on the back of robust growth in remittances and exports, which more than offset the uptick in imports. During July-April FY24, the current account deficit narrowed significantly to US$202 million. In the same period, exports grew by 10.6%, mainly driven by increased quantum of rice and higher value-added textile exports. Conversely, imports decreased by 5.3% during the same period due to lower international commodity prices, better domestic agriculture output and moderate economic activity. Workers’ remittances also remained robust in recent months, reaching an all-time high of US$3.2 billion in May 2024. The resultant lower current account deficit, along with improved FDI and the disbursement of SBA tranche in April, has facilitated ongoing large debt repayments and supported the foreign exchange reserves held by the central bank. Going forward, the Committee stressed that timely mobilization of financial inflows is essential to meet the external financing requirements and further strengthen FX buffers for the country to effectively respond to any external shocks and support sustainable economic growth.

Fiscal sector

Fiscal indictors continued to show improvement during July-March FY24. The primary surplus increased to 1.5% of GDP, while the overall deficit remained almost at last year’s level. A large part of this improvement reflected the impact of increase in tax and PDL rates, higher SBP profit, and lower energy sector subsidies. Considering there has been limited progress in addressing the structural weaknesses to broaden the tax base and initiate energy sector reforms, FY25 budgetary measures are also expected to be largely rate-based. In this backdrop, the Committee emphasized that fiscal consolidation through broadening the tax base and reforming loss-making public sector enterprises would help achieve fiscal sustainability on a more durable basis. This is also imperative to keep inflation on a downward trajectory and contain external account pressures.

Money and credit

The broad money (M2) growth decelerated to 15.2%YoY on May 24, 2024 from 17.1% as of end-March 2024. This reduction was primarily due to deceleration in growth of net domestic assets of the banking system. On the other hand, the growth contribution of net foreign assets in M2 remained positive.

From the liability side, deposits remained the mainstay in M2 growth, while currency in circulation growth decelerated. As a result, reserve money growth observed a steep decline from 10.0% to 4.3% during the period. The MPC noted that these developments in monetary aggregates are consistent with the tight monetary policy stance and have favorable implications for the inflation outlook.

Inflation outlook

Headline inflation decelerated to 11.8% in May 2024 from 17.3% in April. Besides the continued tight monetary policy stance, this sharp reduction was also driven by a sizeable decline in prices of wheat, wheat flour, and some other major food items, along with the downward adjustment in administered energy prices. Core inflation also decelerated to 14.2% from 15.6%. The Committee noted that the near-term inflation outlook is susceptible to risks emanating from the FY25 budgetary measures and future adjustments in electricity and gas tariffs. The MPC foresees a risk of inflation to rise significantly in July 2024 from current levels, before trending down gradually during FY25. The MPC also observed that sharp wheat price reductions have historically proved to be temporary. On balance, the Committee assessed that the current monetary policy stance remains appropriate to ensure that inflation stays on a downward trajectory.

 

 

State of Pakistan Economy

The State Bank of Pakistan (SBP) has released its Annual Report on the State of Pakistan’s Economy for the fiscal year 2022-23. According to the report, Pakistan’s economy faced multiple challenges during the year under review, as longstanding structural weaknesses exacerbated the impact of successive domestic and global supply shocks of unprecedented nature.

The country’s macroeconomic situation had begun to deteriorate since the second half of FY22 in the aftermath of the Russia-Ukraine conflict, elevated global commodity prices and an unplanned fiscal expansion. The situation worsened during FY23 owing to floods, delay in the completion of the 9th review of the IMF’s Extended Fund Facility (EFF) program, continuing domestic uncertainty, and tightening global financial conditions.

Particularly, the devastating monsoon floods significantly dented economic activity, fueled inflationary pressures, increased stress on external account and widened fiscal imbalance because of spending on relief efforts. Similarly, the uncertain global economic and financial conditions, softening – but still elevated – global commodity prices, higher debt servicing and reduced external inflows had implications for various sectors of the economy.

The confluence of these developments substantially weakened Pakistan’s macroeconomic performance during FY23. The real GDP growth fell to the third-lowest level since FY52, whereas average National CPI inflation spiked to a multi-decade high. While the current account deficit narrowed considerably, limited foreign inflows kept pressures on the external account leading to a decline foreign exchange reserves. Meanwhile, reflecting the unsustainable fiscal policy stance of the past many years, a sharp increase in interest payments, persistently large energy subsidies and lower-than-targeted tax collection contributed to less than envisaged fiscal consolidation during FY23.

The report notes that Pakistan’s economic performance in FY23 highlights the importance of addressing perennial structural impediments that pose serious risks to country’s macroeconomic stability. Foremost among these are inadequate and slow tax policy reforms that have constricted the resource envelope, even for meeting current expenditures. On the other hand, inefficiencies in public sector enterprises (PSEs) led to a permanent drain on fiscal resources. These have squeezed

space for development spending required to enhance the economy’s productive capacity. The anemic investment in physical and human capital as well as R&D has impeded development of a technology-intensive manufacturing base and the next level value-added exports. Moreover, stagnant crop yields and lack of attention to development of food supply chain and to address food market imperfections have led to sustained reliance on imported food commodities. These trends underpin the unsustainable current account balance, which has increased the country’s vulnerability to global supply shocks.

The report indicates that this situation requires initiation of broad ranging reforms to address various sectoral imbalances to ensure availability of resources for economic growth and development.

Specifically, expediting tax policy reforms and speedy implementation of governance reforms in PSEs is instrumental to create fiscal space for public investment in human and physical capital.

Furthermore, there is also a need to create a conducive environment to support foreign direct investment in exportable sectors, and to encourage technology transfers. Similarly, agriculture sector reforms are required to alleviate import reliance and for achieving price stability. There is a need to expedite these reforms to achieve a high and sustainable economic growth required to absorb the new entrants in labor market, improve social welfare and raise the general standard of living in the country.

In this context, the availability of factual information on key macroeconomic variables, markets, businesses, and individual welfare are important ingredients for evidence-based policy making. This report includes a special chapter on the need to streamline the state of Pakistan’s National Statistical System (NSS) and identifies some suggestions for NSS reforms.

The report highlights that Pakistan’s economic situation has started to show some early signs of improvement. The country was able to secure a US$3.0 billion Stand-By Arrangement (SBA) from IMF, towards the end of FY23, which helped in alleviating near-term risks to external sector. The high

frequency indicators are suggesting bottoming out of economic activity from July 2023. The withdrawal of guidance on import prioritization, alongside gradual ease in foreign exchange position, is expected to somewhat ameliorate supply chain situation and lift growth in LSM as well as exports. Moreover, an expected rebound in cotton and rice production will support agriculture growth in FY24. Reflecting these considerations, the SBP expects real GDP growth in the range of 2–3 percent in FY24.

The lagged impact of monetary tightening, and other contractionary measures, is expected to keep domestic demand in check. Furthermore, the prospects of improvement in supply situation on account of likely increase in production of important crops and imports is expected to bring down inflation in the range of 20–22.0 percent in FY24. Slightly improved global and domestic growth prospects are expected to bolster foreign exchange earnings from exports of goods and services.

Although import volumes are likely to increase, lower commodity prices may prevent a significant expansion in imports bill during FY24. Accounting for these factors, SBP projects the current account deficit to fall in the range of 0.5–1.5 percent of GDP in FY24.

US Fed hikes rates despite recession fears

The Federal Reserve voted to raise interest rates Wednesday by another 0.25 percentage points, brushing aside concerns about the financial sector and an expected recession later this year.

The Fed’s rate-setting committee voted unanimously Wednesday to boost its baseline interest rate to a range of 5 to 5.25 percent, the point at which Fed officials expected in March to stop hiking rates, according projections from the Fed’s last meeting.

The latest rate hike is the 10th in a row since the Fed began its program of quantitative tightening in March of last year.

Over the past 14 months, the Fed has boosted borrowing costs and shrunk its balance sheet in a historically swift battle with inflation.

There is still some doubt about what the Fed will do at its next meeting in June as both the broader economy and inflation continue to slow. The collapse of First Republic Bank and deepening concerns about financial stability has also shaken confidence in the economy.

“The US banking system is sound and resilient,” according to a Wednesday statement from the Federal Open Market Committee (FOMC), the Fed’s rate-setting panel.

Even so, the FOMC acknowledged that “tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain.”

The Fed may pause on rate hikes and fulfill its March projections for the terminal rate. A rebound in inflation, however, could push Fed officials to keep boosting rates.

Inflation has been decreasing steadily since the middle of last year, with the annual inflation rate falling to 5% in March, according to the Labor Department’s consumer price index.

The broader economy is also slowing under the weight of Fed rate hikes.

US gross domestic product grew at an annualized rate of 1.1% in the first quarter, according to Commerce Department data, much slower than the 2.6% growth rate in the final three months of 2022.

While the unemployment rate has remained near 50-year lows, job gains have been slowing.

Economists expect this trend to continue with the Friday release of the April jobs report.

“The April jobs report should confirm that the labor market slowdown is well underway and that the economy is cooling,” EY economist Lydia Boussour wrote in a Tuesday analysis.

Boussour expects the US to have added 175,000 jobs in April, “a result that would imply a marked downshift in the three-month moving average of job growth from 345,000 to a much cooler 246,000,” she wrote.

Job openings also dipped to 9.6 million in March, according to data from the Labor Department Job Openings and Labor Turnover Survey (JOLTS) released Tuesday, the lowest number in nearly two years.

“JOLTS was a good case for signaling a pause in June,” said Claudia Sahm, a former Fed research director and founder of Sahm Consulting, in an interview with The Hill.

The failure of three major banks within two months and lingering concerns about the delayed impact of Fed rate hikes are also raising the stakes of future increases.

“Historical recessions related to financial market problems tend to be more severe and persistent than average recessions,” the Fed warned in the minutes of its March rate-setting committee meeting

 

State Bank of Pakistan leaves policy rate unchanged

State Bank of Pakistan (SBP) decided to leave the policy rate unchanged at 15% which was in line with market expectations. SBP had cumulatively raised the policy rate by 800bps to 15% since September 2021 to cool down overheating of economy and contain current account deficit.

Further, administrative measures for import control were also taken recently and fiscal consolidation is also planned for FY23.

Inflation in July 2022 increased to 25%YoY as against 21% in June 2022, but broadly remained in line with what SBP had anticipated earlier.

Trade deficit in July 2022 also fell sharply (halved to US$2.7 billion and global commodity prices have also started coming down which will improve our external account situation.

Pakistan also secured additional financing of US$4 billion from friendly countries over and above the available financing to Pakistan.  

After securing additional funding of US$4 billion, revival of IMF program is also in sight as its Board meeting for the approval of Pakistan’s next tranche is scheduled on August 29, 2022.

SBP keeping in view the impact of these decisions like moderation in domestic demand and improvement in external account, decided to keep the policy rate unchanged. 

SBP maintained its inflation forecast of 18% to 20% for FY23. It also anticipates it to improve to 5% to 7% by the end of FY24.

SBP expects GDP growth for FY23 to be in the range of 3% to 4% as against growth of 6% last year.

Current Account deficit is projected to be around 3% of GDP or US$10 billion) in FY23 as against US$17 billion or 4% of GDP in FY22. 

The SBP Monetary Policy Committee promises to continue to remain data driven and pay attention on inflation expectations, development on fiscal & external front, global commodity prices and interest rates decisions by major central banks.

Foreign exchange reserves are likely to increase to US$16 billion by FY23. This will be driven by additional financing that will be available to Pakistan in FY23. This will also be dependent upon Pakistan following key measures agreed with IMF and remaining on track with the program.

Pakistan’s gross financing needs would be around US$30 billion for FY23 which includes Current Account Deficit and debt repayments.

Available financing against this is estimated at US$37 billion for FY23, which has increased after Pakistan secured US$4 billion of financing from friendly countries.    

Financing of US$4 billion includes US$2 billion from Qatar, US$1 billion of deferred oil facility from Saudi Arabia, and US$1 billion investment from UAE. 

Pakistan’s short term external debt constitute around 6% of the total external debt hence maturity profile of Pakistan external debt is not an issue. However, low private sector flows like FDI and portfolio investment is a key concern. 

FY23 budget targets a primary surplus, on the back of significantly higher tax revenue. It envisages a strong fiscal consolidation of around 3% of GDP as per SBP.

 

Pakistan: What will be SBP decision regarding policy rate?

Monetary Policy Committee (MPC) of State Bank of Pakistan (SBP) is scheduled to meet on August 22, 2022. It has three options: 1) increase, 2) decrease and 3) let unchanged at 15%.

May I request you to first read two of my blogs: Central banks around the world raising interest rates to tame inflation and Get ready for another interest rate hike and then the brief prepared by one of Pakistan’s leading brokerage houses.

Topline Securities says, signs of a slowdown have begun to emerge, with several high frequency growth indicators recording a sharp drop on MoM readings – although some of the same can be attributed to the ongoing monsoon season in the country too.

Nevertheless, sectors posting decline are Cement (61%MoM), Automobile (58%MoM), POL products (26%MoM) have all posted significant drop in sales as per latest data, along with 23%MoM drop in exports during July 2022 as well.

Moreover, the industrial sector has been struggling due to: 1) restrictions on imports including plant & machinery; 2) higher interest rates amid record inflation; 3) soaring fuel and power cost; 4) squeeze on margins; 5) volatile Rupee and 6) flattish or falling demand for their products as purchasing power diminishes due to higher taxes and record surge in headline inflation.

The brokerage house believes hiking interest rates would have limited effect on curbing headline inflation, which is being largely driven by supply-side factors including higher fuel and energy prices, with lagged effect on core inflation.

The pressure on Rupee has subsided significantly with Pakistan inching closer to the next IMF disbursement  as well as enhanced monitoring of exchange operations by the SBP.

The SBP and the Ministry of Finance have also assured that Pakistan’s gross financing needs will be more than fully met for FY23. Support from friendly countries: 1) China—roll over of US$4.3 billion in deposits and commercial loans; and 2) Saudi Arabia—renewal of US$3 billion deposit, with the possibility of extending KSA’s SDR’s to Pakistan, have also boosted confidence in the Rupee.

The yields in the primary market have remained almost unchanged since the last MPC was announcement in July 2022. However, secondary market yields have increased in line with the movement in the policy rate since the last MPC announcement, and do not seem to reflect expectations of another rate hike for now.   

 

Wall Street Rattled

On Tuesday, April 26, 2022, stocks witnessed a steep decline in technology stocks that deepened Wall Street losses after a brutal start to 2022.

Dow Jones Industrial Average closed with a loss of 809 points, a decline of 2.4%. Nasdaq composite closed with a loss of 4% and S&P 500 index fell 2.8% by the closing bell

Following a year of stellar gains, all three indices have fallen since the start of the year as investors brace for the continued war in Ukraine, high inflation and the Federal Reserve’s attempts to cool off price growth to cut into corporate profits. Tech stocks that made up much of the market’s massive gains last year are among the leading forces behind the steady decline across Wall Street.

The tech-heavy Nasdaq is down more than 21% on the year, falling into a bear market as shares of Apple, Meta, Alphabet, Netflix and Tesla plunge from record highs. All posted significant losses Tuesday, with a 10% drop in Tesla stock leading the index downward.

The S&P is down 13% on the year, beyond what investors consider a correction, and the Dow is down 9.1% since the start of 2022.

All three indices have closed out the past three weeks with losses, reversing a brief comeback derailed by concerns about growing threats to business revenue.

Both the war in Ukraine and COVID-19 lockdowns in China have boosted pressure on prices for food, energy, shipping and manufacturing after more than a year of high inflation across the globe.

Deeper supply chain issues pose a major obstacle to the Fed as it attempts to raise interest rates fast enough to reverse inflation but slow enough to keep the strong US economy growing and adding jobs.

Higher interest rates raise borrowing costs for consumers and businesses, which can hinder business investment and shrink corporate profit margins. Stocks often fall as the Fed raises interest rates, particularly when investors fear the bank may need to hike quicker than they currently anticipate or higher than investors had expected.

“The Fed is raising rates to get inflation under control. This is painful in the short term, but necessary to lay the foundation for future growth. As always, we just need to ride out the short-term pain to benefit from that future growth,” wrote Brad McMillan, Chief Investment Officer for Commonwealth Financial Network, in a Monday research note.

Some economists and investment experts have become increasingly worried about the US economy falling into a recession this or next year as the Fed fights inflation amid several global obstacles. While there is no one universal definition of a recession, some banks and economists expected three to six months of negative economic growth within the next 12 to 18 months.

“We regard it … as highly likely that the Fed will have to step on the brakes even more firmly, and a deep recession will be needed to bring inflation to heel,” Deutsche Bank economists wrote in a report to clients Tuesday, CNN reported.

Other experts believe recession fears are overhyped given the strength of the US economy and the likelihood that inflation has peaked in the United States. The US added 1.7 million jobs over the first three months of 2022, and consumer spending has been resilient in the face of high price growth, thanks in part to rapid wage growth in low-income fields.

 “In spite of these risks, the metrics suggest that the economy could escape a recession in the near term, with potential for nearly 3% growth this year,” wrote Jeffrey Roach and Lawrence Gillum of investment firm LPL Financial, in a Monday research note.

“On balance, we think the economy is steady enough to handle the current tightening cycle even if the Fed is coming late with its hawkish tones,” they added.

 

Will BoE and US Fed be on the same page?

The US Federal Reserve has made it official that starting later this month, it will reduce their monthly bond purchases by US$15 billion ($10 billion Treasuries, $5 billion mortgage backed securities). By June 2022, the bond buying program should come to an end. 

The Fed explains that pandemic stimulus can start to be unwound as “substantial further progress in the economy has (been) made toward the Committee’s goals since December 2021.” They left interest rates unchanged, which was expected and continued to use the word “transitory” to describe inflation.  

While some investors believed they would drop this language, it did not seem to matter as once the dust settled, USD ended the day virtually unchanged (slightly lower) from its pre-FOMC levels against other the major currencies. Stocks and bond yields ended higher which should benefit JPY crosses.

Looking ahead to Friday’s non-farm payrolls (NFP) report, economists expect a significant recovery in job growth during the month of October.  A large part of this has to do with the slowdown in September, when non-farm payrolls rose by only 194,000. That number is expected to more than double this week with a consensus forecast of 450,000. 

According to ADP, private sector payroll growth was very strong last month but even though service sector activity hit a record high in October, the shortage of workers drove the employment index lower. As one of the most important leading indicators for non-farm payrolls, this suggests that while more jobs are expected in October, the increase may fall short of the market’s lofty forecast. 

Will BoE hike rate today?

While the countdown to Friday’s NFP report has started, analysts have shifted focus to the monetary policy announcement by the Bank of England (BoE) on Thursday. In many ways, the BoE rate decision should have a greater impact on GBP than FOMC did on the USD because the UK central bank is close to raising interest rates.

As the second major central bank to reduce asset purchases, the BoE has been leading the pack in unwinding pandemic support and with inflation surging, a small contingent of investors believe they could hike as quickly as Thursday. The market is pricing in a 60% chance of 15bp hike which means a full quarter point move is unlikely. However the central bank has done a smaller adjustment before so we can’t rule out that possibility completely.

BoE Governor Bailey and monetary policy committee member Saunders have suggested that an immediate hike may be needed but other policymakers want to see further improvements in labor market activity or evidence that inflation is less transitory before making the move.

With the Reserve Bank of New Zealand raising rates, Bank of Canada announcing ending to Quantitative Easing and the Fed beginning to reduce asset purchases, there is a decent chance for a rate hike by the BoE. It may not be a full quarter point, but it could be 15bp increase. 

The immediate tightening should be wildly positive for the greenback as it is not really anticipated. However, if they forgo a rate hike in November, then a hike in December becomes very likely.

In this scenario, analysts expect no change to be accompanied by hawkish comments which could be initially negative but ultimately positive for GBP. Either way, barring an unexpected surprise analysts see GBP strengthening post BoE announcement, particularly against EUR.