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SBP’s measure to cool down the heated economy

SBP decided to raise the policy rate by 125 basis points (bps) to 15 percent

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The State Bank of Pakistan (SBP) Amendment Bill 2021 proposed domestic price stability as the primary objective of the central bank. On Thursday, SBP decided to raise the policy rate by 125 basis points (bps) to 15 percent with the perspective of cooling down the heated economy, hold inflation and strengthening a troubled PKR.

The current policy rate is at a 14-year high level as the previous policy rate at the same level was in 2008.  Furthermore, to strengthen monetary policy transmission, the committee stated that interest rates on EFS and LTFF loans will now be linked to the policy rate.

Read more: State Bank hikes base interest rate by 150 bps

SBP Acting Governor Dr. Murtaza Syed announced the monetary policy decision in a virtual press conference following the MPC meeting on Thursday. He told the media that worldwide inflation has reached its peak since 1970. He added, “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.”

He praised the government’s recent actions, notably the elimination of petroleum subsidies, stating that they prepared the path for the completion of the IMF loan program. The anticipated completion of the ongoing IMF review would generate significant additional funding from external sources, ensuring that Pakistan’s external finance needs are met for FY23. Stress on the Rupee should then ease and the SBP’s FX reserves should gradually resume their prior upward trend during FY23.

According to him, GDP growth is expected to moderate to 3-4 percent in FY23 because of monetary tightening and fiscal consolidation, which will aid in closing the positive output gap and reducing demand-side pressures on inflation.

According to the MPC’s baseline forecast, headline inflation is projected to stay elevated around 19-20% in FY23 before falling substantially to the 5-7% target range by the end of FY24, driven by tight policies, normalization of global commodity prices, and favorable base effects.

The MPC will continue to be data-dependent in the future, paying close attention to month-on-month inflation, the evolution of inflation expectations and global commodity prices, as well as fiscal and external developments.

According to Syed, raising the key policy rate and linking export finance rates to the policy rate will assure the economy’s smooth landing in an unusually tough and uncertain global environment.

Three positive developments have occurred since the last MPC meeting. Firstly, the unsustainable energy subsidy package was repealed, and FY23 budget focusing on rigorous fiscal consolidation was approved. This has prepared the path for completion of the on-going review of the IMF program, which will confirm that tail risks related with meeting Pakistan’s external financing needs are deterred.

Secondly, a $2.3 billion commercial loan from China aided in bolstering FX reserves, which had been declining since January based on current account constraints, external debt repayments, and a lack of foreign inflows. Thirdly, economic activity stays robust, with the momentum of the last two years of around 6 percent growth carrying into the start of FY23. Resultantly, Pakistan confronts a much lower trade-off between growth and inflation than many other nations where the post-Covid recovery has been less vigorous.

However, some negative developments, according to the SBP, have dominated these positive achievements. In most nations, inflation is at multi-decade highs, and central banks are responding strongly, putting downward pressure on most emerging market currencies.

This substantial monetary tightening has occurred despite fears about a slowdown in global growth and even recession prospects, emphasizing the importance that central banks place on limiting inflation at this time.

Considering this difficult situation, the MPC emphasized the significance of robust, timely, and credible policy steps to curb domestic demand, prevent inflationary pressures from accumulating, and decrease threats to external stability. Pakistan, like the rest of the world, is experiencing a significant negative income shock as a result of rising inflation and required but painful increases in utility prices and taxes. There is a significant risk of substantially worse consequences if meaningful macroeconomic adjustments are not made, threatening price stability, financial stability, and growth.