Daily The Business

SBP policy rate up by 150bps to 10.0 percent

M J Hayat

LAHORE:  The State Bank of Pakistan (SBP) Monetary Policy Committee is
of the view that further consolidation is required to ensure
macroeconomic stability and therefore it has decided to raise the SBP
policy (target) rate by 150bps to 10.0 percent effective from 3rd
December 2018.
The SBP Committee observed the economic data released since the last
Monetary Policy Committee meeting in September 2018 shows that the
positive impact of recent stabilization measures has started to
materialize gradually.  Particularly, the current account deficit is
showing early signs of improvement. However,the near term challenges
to Pakistan’s economy continue to persist with rising inflation, an
elevated fiscal deficit and low foreign exchange reserves.These
concerns are also capture in the results of recent consumer and
business confidence surveys.

Average headline CPI inflation during the first four months of FY19
has increased to 5.9 percent as compared to 3.5 percent in the
corresponding period of FY18. This trend is even more pronounced for
core inflation,which indicates growing inflationary pressures in the
economy. A disaggregated analysis reveals that this is due to both,
demand and supply side factors. Considering these developments, SBP
projects average headline CPI inflation for FY19 in the forecast range
of 6.5–7.5 percent, above the annual target of 6.0 percent. Although
the recent decline in international oil prices could potentially play
a positive role in slowing down the current inflation trajectory the
risks currently remain tilted towards the downside.

Taking a lead from the recent large scale manufacturing data, economic
activity is expected to witness a notable moderation during FY19 –
reflecting a short term cost of pursuing macroeconomic stability. The
lagged impact of the 275 basis point increase in the policy rate since
January 2018 and other policy measures is likely to contain domestic
demand during the current fiscal year. Furthermore, initial estimates
for  major crops, except wheat, are expected to fall short of levels
achieved in the last year.The slowdown in commodity producing sectors
is expected to limit the expansion in the services sector as well. In
this backdrop, SBP projects real GDP growth for FY19at slightly above
4.0 percent.

On the external front, import growth decelerated to 5.8 percent during
Jul-Oct FY19 from 26.3 percent recorded in the same period last year
reflecting the impact of recent tightening measures.Even this growth
in imports is mainly explained by an increase in the oil import bill
because of higher international oil prices.Non-oil imports contracted
by 4.0 percent in the first four months of FY19. This, along with a
continued increase in exports and workers’ remittances,narrowed the
external current account deficit from US$5.1 billion in Jul-Oct FY18
to US$4.8 billion in Jul-Oct FY19; a net improvement of 4.6 percent.
Despite these positive developments, SBP’s net liquid foreign exchange
reserves remained under pressure falling toUS$8.1 billion as of 23rd
November 2018 from US$9.8 billion at the end of FY18.

Going forward, there is an expectation of receiving higher foreign
inflows from both private and official sources during the second half
of FY19. Furthermore, recent bilateral arrangementsincludingthe
deferred oil payments facility would also be available to the market
from January 2019 onwards. The projected decrease in the current
account deficit, that could be further supported by the recent decline
in international oil priceswill instill confidence in the foreign
exchange market. These developments would help reduce pressures on
SBP’s net liquid foreign exchange reserves.

In the first four and a half months of FY19,statistics show that
almost all liquidity in the banking system is generated through an
increase in the Net Domestic Assets (NDA) as the Net Foreign Assets
(NFA) continued to contract. Besides the increase in budgetary
borrowings from SBP, relatively higher credit flows to the private
sector have been the major contributors to an increase in NDA. Despite
contractionary monetary conditions, an increase in working capital
needs due to capacity additions in the last three years and recent
substantial increases in input prices, are the main reasons behind
relatively higher credit flows to the private sector.

After considering all of these developments, the Monetary Policy
Committee noted that: (i) continued inflationary pressure(and rising
inflationary expectations)needs to be checked;(ii) real interest rates
remain low; (iii) although narrowing,the current account deficit is
still high and the fiscal deficit remains elevated;and (iv) unfolding
global developments, particularly the gradual but consistent
normalization of monetary policy in the developed economies demands
proactive domestic monetary management.

In light of the current and evolving macroeconomic situation discussed
above, the Monetary Policy Committee is of the view that further
consolidation is required to ensure macroeconomic stability and
therefore has decided to raise the SBP policy (target) rate by 150bps
to 10.0 percent effective from 3rd December 2018.

On strategies to overcome the country’s recurrent balance-of-payments
challenges in the medium term,MPCopined that:(i) with the exchange
rate reflecting a demand-supply gap in the foreign exchange market,
the adoption ofa flexible inflation targeting framework will help
anchor inflation expectations;(ii) improving productivity and
competitiveness of exports will have to play a prominent role to
reduce the external trade deficit; and (iii) the fiscal policy will
have to be proactive and play a supportive role to generate conditions
for a sustainable growth path.

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