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SBP decides to raise the key interest rate

The State Bank of Pakistan's Monetary Policy Committee has decided to increase the policy rate of the country for the next two months by 25 points basis to 7.25 per cent. This according to the statement is in line with the positive economic recovery.

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The Monetary Policy Committee (MPC) has held its scheduled session today in accordance with the calendar launched by the State Bank of Pakistan (SBP) in May 2021.

At its meeting on 20th September 2021, the Monetary Policy Committee (MPC) decided to raise the policy rate by 25 basis points to 7.25 percent, the statement read.

The meeting has announced the monetary policy of Pakistan for the next two months, keeping in mind the growth rate target set by the government, the increasing trade deficit, and growing inflation in the country.

The statement read that the “economic recovery of the country has exceeded expectations.”

“In line with this shift in the economic outlook, the MPC was of the view that the priority of monetary policy also needed to gradually pivot from catalyzing the recovery after the Covid shock toward sustaining it,” MPC statement read. 

The statement read that this rebalancing would be best achieved by gradually tapering the significant monetary stimulus provided over the last 18 months.

The MPC noted that over the last few months the burden of adjusting to the rising current account deficit had fallen primarily on the exchange rate and it was appropriate for other adjustment tools, including interest rates, to also play their due role.

The MPC noted that the stance of monetary policy is still appropriately supportive of growth, with real interest rates remaining negative on a forward-looking basis.

The statement also hinted at further monetary tightening over the next months. It read, “Looking ahead, in the absence of unforeseen circumstances, the MPC expects monetary policy to remain accommodative in the near term, with possible further gradual tapering of stimulus to achieve mildly positive real interest rates over time.

The speed of tightening would depend on continued demand growth, the stance of fiscal policy, among other factors.

External Sector

MPC recognized both the widening trade deficit and rupee depreciation over the last few weeks.

Due to the domestic demand, and increased global commodity prices, imports outstripped the positive role played by the strong remittances and positive exports, leading to the Pakistani rupee depreciating 4.1 per cent since the last MPC meeting, the statement read.

MPC noted that the flexible market-based exchange rate regime has been good for the economy. The statement noted, “Since its floatation, the rupee has moved in an orderly manner in both directions and has depreciated by only 4.8 percent to date, much less than many other emerging market currencies over the same period.”

The statement, however, said that the role of floating exchange rate as shock absorber must, “be complemented by strong exports, targeted measures to curb nonessential imports, and appropriate macroeconomic policy settings to contain import growth.”

Background

The policy rate has been maintained at 7 per cent since the meeting in June 2020, when the MPC of the State Bank had decided to cut it by 100 basis points, compared to the previous rate of 13.25 pre-pandemic.

The committee had commented in the last meeting in July that the pandemic was not over and the country was going through the fourth wave of the coronavirus in view of which it wanted to “give a feeling of stability to the nation” and show that the SBP’s “supportive monetary policy” would be maintained, Reza Baqir had said.

In light of this view from the last meeting, some people believe that the central bank will maintain the policy rate at 7 per cent, while there are others who believe a small hike.

Pakistan’s leading security brokerage AKD’s analysts expect status quo on the interest rates.

It is worth mentioning that there was some expectation of an interest rate increase in the last few weeks as rupee depreciation sped up and the recent reports of widening current account deficits.

The experts who say that the interest rate will increase, believe that the SBP would hint at making a token increase of 25-50 basis points in the monetary policy in November 2021 or in January 2022 under its newly adopted global practice of deliberating forward guidance.

Pakistan’s current account deficit has swelled to reach $1.48 billion for the month of August, showing a stark increase of 81 per cent a month-on-month (MoM) basis, SBP data from 17th September showed.

Similarly, the country’s rising import bill is becoming a major concern, as the second month of the ongoing fiscal year, 2022 saw the widening of the trade deficit by 133 per cent, while the imports increased two times more than the increase in exports as the economy gained momentum.

The interest rate and flexible rupee-dollar parity are the two major tools available with central banks all over the world to control inflation and give a direction to the economic trajectory in their respective countries.

Thus, to curb inflation, while keeping the economy running, as not to make the rate too high in fear of deterring investors, a small increase(25 basis) in policy rate is expected by many.

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