SBP increases monetary policy rate to 7.5 percent

KARACHI: State Bank of Pakistan on Saturday announced to increase the monetary policy by 100 basis points to 7.50 percent effective from July 16, to curb demand and ensure near-term stability.

According to a statement by the monetary policy committee, Pakistan achieved a thirteen-year high growth rate of 5.8 percent in FY18 and the average inflation was well below the 6.0 percent target.

However, the challenges to Pakistan’s economy have further accentuated. Firstly, the provisional estimate for fiscal deficit for FY18 is 6.8 percent as opposed to 5.5 percent estimated in May 2018.

The current account deficit has also increased to $16.0 billion during May-July FY18 as opposed to the corresponding period last year, which implies that aggregate demand is higher than previously thought.

Second, inflation in June clocked in at 5.2 percent, and the average headline inflation for next fiscal year is expected to cross the 6 percent annual target. The core inflation numbers and their further projections at around 7 percent also reflect demand pressures.

Third, on the external front, though both exports and workers’ remittances are performing better, the sheer size of imports continues to pressurise foreign exchange reserves.

GDP growth rate target reduced to 5.5%

The real economic activity repeated its strong performance in FY17, but some challenges cast shadows on the capacity of the real sector to continue treading this high growth path towards the end of FY18.

The shortage of water is the most important concern for the agricultural sector and can affect production next year. The manufacturing sector is poised to show a mixed picture owing to high base-effect, monetary tightening and other issues, whereas construction-allied industries are likely to perform at par.

Taking stock of these developments and the spillover on the services sector, the central bank projected GDP growth for FY19 to be around 5.5 percent as compared to the annual target of 6.2 percent.

Inflation rate to project to rise to 6-7% in FY19

The average headline inflation for FY18 stands at 3.9 percent, but can be effected due to rising headline and core inflation for June 2018 at 5.2 and 7.1 percent respectively. Based on these recent estimates, the inflation rate is projected between 6-7 percent for FY19.

This assessment relies on a higher fiscal deficit, food inflation reverting to its normal behaviour, unfavorable trend in international oil prices, lagged pass-through of rupee depreciation, and high measures of inflation expectations.

Monetary expansion in FY18 has been driven by government borrowing for budgetary healthy growth in credit to the private sector. Despite some slowdown in fixed investment and issues in sugar and fertilizer sectors, private sector borrowing increased by Rs.768 billion in FY18 which translates into a growth of 14.8 percent.

Private sector credit is expected to increase by almost the same amount at a growth rate of about 13 percent in next fiscal year. This will be driven primarily by the rise in need for working capital due to lagged fixed investment in production and rising exports.

The expansionary impact of net domestic assets (NDA) on money supply has been partially neutralised by 5.4 percent net contraction in foreign assets of the banking sector by Rs.793 billion during FY18.  As a result, broad money supply saw a net expansion of 10.6 percent during FY18 as compared to 13.7 percent during FY17.

Current account deficit deteriorated to $16bn

Furthermore, the current account deficit deteriorated to $16.0 billion during the first eleven months of FY18, which is 1.4 times over the same period last year.

Exports witnessed 13.2 percent growth in FY18, while remittances increased by 3 percent which offset by growing imports. The strong demand for productive imports, such as metal, transport, machinery and petroleum, to support higher economic activity and a sharp increase in international oil prices have pushed the current account deficit to levels not sustainable beyond the short term.

A notable portion of this higher current account deficit was financed by using the country’s own resources in the absence of matching financial flows. As a result, the central bank’s liquid reserves witnessed a net reduction of US$ 6.7 billion to reach US$ 9.5 billion as of July 6.

The central bank’s monetary policy committee noted several factors contributing to evolving economic challenges: (i) the multiplier second half of FY18 is likely to offset the impact of monetary tightening in the recent months on domestic demand; (ii) higher international oil prices have continued to inflate the import bill; (iii) rising inflation projections and (iv) the reduction in Pakistan rupee and US dollar interest rate differential and therefore decided to increase the monetary policy rate.