KARACHI: The State Bank of Pakistan on Friday decided to raise the monetary policy by 25 bps to six percent, in order to preempt overheating of the economy and inflation breaching its target rate, considering that the policy decision would balance growth and stability in the medium to long term.
The central bank said that the policy rate decision is based on four key factors the economy has witnessed important changes since November 2017.
Firstly, the Pakistani rupee has depreciated by around five percent, and secondly oil prices are hovering near US $70 per barrel. Thirdly, several central banks have started to adjust their policy rates upwards adversely affecting interest rate differentials with regard to their currencies. Lastly, multiple indicators show that the output gap has significantly narrowed indicating a buildup of demand pressures.
It stated that Pakistan’s economic growth is on track to achieve its highest level in the last eleven years. The average headline inflation remains within the forecast range, but core inflation has continued to increase. The fiscal deficit for the first half of the fiscal year is expected to fall close to the last year’s 2.5 percent.
There has also been visible improvement in export growth and remittances are marginally higher, but current account deficit remains under pressure largely due to high level of imports. The exchange rate adjustment in December 2017 is expected to help ease the pressure on the external front.
The agriculture sector is set to perform better for the second year in a row. The production of all major kharif crops, except maize, has surpassed the level of fiscal year 2017.
Similarly, large scale manufacturing (LSM) recorded a healthy growth of 7.2 percent during Jul-Nov FY18 as compared to 3.2 percent during the same period last year. The overall industrial activity is likely to remain strong despite deceleration in sugar, petroleum products and fertilizer sector.
The construction and its allied industries are expected to maintain their higher growth momentum benefiting from both infrastructure and CPEC related investments.
GDP growth rate projected at 5.8 pct
After incorporating the impact of commodity sector dynamics on the services sector, the real GDP growth is projected to be around 5.8 percent.
This is significantly higher than FY17, but marginally lower than the annual target of 6 percent for FY18, and is largely due to expectations of a below-target wheat crop because of a reduction in area under cultivation.
The average headline inflation for first half of FY18 stands at 3.8 percent, while core inflation maintained its higher trajectory, and clocked in at 5.5 percent during the first half of the year as compared to 4.9 percent last year. This is likely to increase inflation in the coming months.
Taking into account the impact of all these developments, the average inflation for FY18 is still projected to fall in the range of 4.5 to 5.5 percent, end of fiscal year inflation is likely to inch towards the annual target of 6 percent.
The money supply grew marginally by 1.9 percent during 1st Jul-12th Jan FY18. This is a reflection of the decline in net foreign assets (NFA) and government efforts to contain expenditures.
Higher tax collection and proceeds from the issuance of Sukuk and Eurobond have led to reduction in net budgetary borrowing which stood at Rs. 401.9 billion during July 1 – Jan 12 FY18 as compared to Rs. 470.4 billion in the corresponding period of the previous year.
Moreover, the delay in the sugar crushing season also contributed to a moderation of demand in private sector credit. On the external front, export receipts posted the highest growth in the last seven years of 10.8 percent in first half of FY18 against a reduction of 1.4 percent in first of preceding fiscal year.
Foreign exchange reserves dropped to $13.5 bn
Worker’s remittances also recorded growth of 2.5 percent during the first half of the year as compared to a decline in the same period last year. However, the favorable impact was overshadowed by the continued strong growth in imports of goods and services.
The current account deficit widened to US$ 7.4 billion during the first half of the year, which was 1.6 times of the deficit during the same period last year. Developments in financial accounts show that one-fifth of this deficit was financed by healthy foreign direct investments inflows, and the rest was managed by the official flows and the country’s own resources.
As a result, SBP’s liquid foreign exchange reserves witnessed a decline of US$ 2.6 billion since end June 2017 to reach US$ 13.5 billion as of 19 January 2018.
Furthermore, the rupee depreciation in December 2017, the export package, lagged impact of adjustments in regulatory duties, favorable external environment, and expected increase in workers remittances will contribute to a gradual reduction in the country’s current account deficit.
The increase in international oil prices pose a major risk to this assessment and managing overall balance of payments in near term depends on the realisation of official financial flows.
