SBP announces monetary policy, current account deficit narrows to $8.8bn

KARACHI: The State Bank of Pakistan (SBP) on Friday released the monetary policy, indicating sizeable contraction in the current account deficit during the first two months of 2019, ARY News reported.

The SBP policy was announced after a meeting of the central bank’s Monetary Policy Committee.

Interest rate hiked

The central bank raised the key policy rate by 25 basis points to 10.25 percent in January in the face of high fiscal and current account deficits and continuing inflationary pressures.

The current account deficit recorded a sizeable contraction, which, together with bi-lateral inflows, helped ease pressures on SBP’s foreign exchange reserves, said the SBP.

“These developments on the external front have improved stability in the financial markets, reduced uncertainty and improved businesses confidence, as reflected in various surveys. Nonetheless, despite narrowing, the current account deficit remains high, fiscal consolidation is slower than anticipated, and core inflation continues to rise.”

CPI inflation rate

The SBP further says the consumer price index (CPI) inflation will fall in the range between 6.5% and 7.5% for the fiscal year 2019.

Read also: Controlling inflation top priority: SBP governor

“Rising input costs on the back of higher energy prices and the lagged impact of exchange rate depreciation are likely to maintain upward pressure on inflation despite a moderation in aggregate demand due to a proactive monetary management.”

However, the year-over-year (YoY) CPI inflation has risen considerably to 7.2 percent in January 2019 and further to 8.2 percent in February 2019 – the highest YoY increase in inflation since June 2014.

Causes of growing inflation

These pressures on inflation are explained by adjustments in the administered prices of electricity and gas, significant increase in perishable food prices, and the continued unfolding impact of exchange rate depreciation.

“Core inflation maintained its 13-month upward trajectory accelerating to 8.8 percent in February 2019 from 5.2 percent a year earlier”, says the SBP report.

The report said amidst the efforts to curtail inflationary pressures and reduce the otherwise widening macroeconomic imbalances, domestic economic activity experienced the brunt of the stabilization measures implemented as yet.

Current accounts deficit narrows

The SBP underlined that the current account deficit narrowed to $ 8.8 billion in Jul-Feb fiscal year-2019 as compared to a deficit of US$ 11.4 billion during the same period last year, indicating a fall of 22.6 percent.

“This includes a notable pace of retrenchment of the current account deficit by 59.9 percent during the first two months of 2019 over the same period last year. This reduction in the external balance was mainly driven by a 29.7 percent decline in the trade deficit in goods and services as well as a strong growth in remittances.”

The report says the reduction in the trade deficit was in large part driven by import compression.

The SBP added that exports, in dollar value, during this period remained flat, however in terms of quantum there had been a notable improvement. “Despite this fact, a significant challenge remains in term of its financing; the narrowing of the current account deficit has translated into some stability in the foreign exchange market.”

Foreign exchange reserves ‘recovering’

With an improvement in the external balance as well as an increase in bilateral official inflows, SBP says its foreign exchange reserves gradually recovered to US$ 10.7 billion on March 25, 2019. However, it adds “the reserves are still below the standard adequacy levels (equal to three months of imports cover), the recent improvement on the external front has nevertheless improved business confidence.”

Structural reforms needed

The central bank suggested that concerted structural reforms were required to reduce the trade deficit by improving productivity and competitiveness of the export-oriented sectors.

The fiscal deficit for the ongoing fiscal year was higher at 2.7 percent of GDP when compared with 2.3 percent for the same period last year. In view of the shortfalls in revenue collections and escalating security-related expenditures it is most likely that the target for the fiscal deficit in FY19 would be breached.

“So far, a significant portion of the fiscal deficit was financed through borrowings from SBP, which if continued, will not only complicate the transmission of monetary policy but also dilute its impact and prolong the ongoing consolidation efforts,” stated the SBP.

The State Bank said Large-scale Manufacturing (LSM) declined by 2.3 percent during Jul-Jan of the current fiscal year against 7.2 percent growth recorded in the same period last year. The latest available estimates of major crops also depict a lackluster performance by the agriculture sector.

“The slowdown in commodity producing sectors has downside implications for growth in services sector as well. Similarly, a deceleration in consumer demand and capital investments, reflected through a cut in development spending and deceleration in credit for fixed investments, indicates a moderation in domestic demand. In this backdrop, the real GDP growth is projected to be around 3.5 percent in FY19, the report concludes.