Pakistan’s central bank hikes key interest rate to 10% to ensure “macroeconomic stability”

KARACHI: The State Bank of Pakistan on Friday increased its baseline interest rate by 150 basis points from 8.5 percent to 10 percent. Explaining the decision, which was above market expectations, the bank said “further consolidation is required to ensure macroeconomic stability.”
Muzamil Aslam, a senior economist, said: “The market was expecting an increase of 100 basis points.
“Though economic indicators are favorable, the 1.5 percent hike shows that they are under pressure from the International Monetary Fund.”
The IMF had been pushing Pakistan to push the key policy rate into double digits.
The SBP said: “The opinion of the Monetary Policy Committee is that with the exchange rate reflecting a demand-supply gap in the foreign-exchange market, the adoption of a flexible inflation-targeting framework will help anchor inflation expectations. Improving productivity and competitiveness of exports will have to play a prominent role to reduce the external-trade deficit, and the fiscal policy will have to be proactive and play a supportive role to generate conditions for a sustainable growth path”.
Average headline consumer price index (CPI) inflation during the first four months of the current fiscal year (FY19) rose to 5.9 percent, compared with 3.5 percent during the corresponding period of FY18, the bank noted.
Its forecasts suggest average CPI inflation for FY19 of between 6.5 percent and 7.5 percent, a little above the target of 6 percent. Although the recent decline in international oil prices might help to ease inflation, the risks currently remain tilted toward the downside.
Taking a lead from recent large-scale manufacturing data, economic activity is expected to be moderate during FY19, reflecting the short-term cost of pursuing macroeconomic stability.
SBP predicts that real gross domestic product growth for FY19 will be slightly more than 4 percent. The cumulative effects of a 275 basis point increase in the interest rate since January 2018 and other policy measures are likely to suppress domestic demand during the current fiscal year. Initial estimates for major crops, except wheat, are expected to fall short of levels achieved in the previous year. The slowdown in commodity-producing sectors is expected to limit expansion in the services sector as well.
Import growth fell to 5.8 percent during July-Oct. FY19 from 26.3 percent during the same period a year ago, reflecting the impact of recent belt-tightening measures. The remaining growth is mainly the result of the increased cost of oil because of higher international prices. Non-oil imports fell by 4 percent during the first four months of FY19. This, along with continued increases in exports and remittances from overseas Pakistanis, narrowed the external current-account deficit from $5.1 billion in July-Oct. FY18 to $4.8 billion during the same period in FY19, a net improvement of 4.6 percent.
“Despite these positive developments, SBP’s net liquid foreign-exchange reserves remained under pressure, falling to $8.1 billion as of November 23, 2018, from $9.8 billion at the end of FY18”, the bank added.
Looking to the future, there is an expectation of higher foreign inflows from both private and official sources during the second half of FY19. In addition, recent bilateral financial agreements, including a deferred oil-payment facility from Saudi Arabia, will be available to the market from January 2019. The projected decrease in the current-account deficit, which might be further supported by the recent decline in international oil prices, are likely to instill confidence in the foreign-exchange market. These developments could help reduce the pressures on SBP’s foreign-exchange reserves.
During the first four and a half months of FY19, almost all of the liquidity in the banking system was generated through an increase in net domestic assets (NDA) as net foreign assets continued to contract. Besides an increase in budgetary borrowings from SBP, relatively higher credit flows to the private sector have been the major contributor to the NDA increase.
Despite contractionary monetary conditions, an increase in working-capital needs, due to capacity additions in the past three years and recent substantial increases in input prices, are the main reasons behind relatively higher credit flows to the private sector.
The bank’s Monetary Policy Committee noted that the continuing inflationary pressure from rising inflationary expectations needs to be checked; real interest rates remain low; although narrowing, the current-account deficit is still high and the fiscal deficit remains elevated; and unfolding global developments, particularly the gradual but consistent normalization of monetary policy in developed economies, demands proactive domestic monetary management.