State Bank policy rate

The State Bank of Pakistan has announced its new monetary policy, raising the policy rate for the first time in four years by 25bps to 6 percent. The central bank has kept the discount rate unchanged at 5.75% since May 2016, which is the lowest level in four decades. The interest rate was in double digits at 10% in the first half of fiscal year 2012-13 before easing inflationary pressure led to a decline in the interest rate. Citing reasons for raising the policy rate, SBP has clarified that Pakistan’s economic growth is on track to achieve its highest level in the last eleven years. Average headline inflation remains within the forecast range, but core inflation has continued to increase. Fiscal deficit for H1-FY18 is expected to fall close to the last year’s 2.5 percent. There has been visible improvement in export growth and remittances are marginally higher.

However, largely due to high level of imports, the current account deficit remains under pressure. The exchange rate adjustment in December 2017 is expected to help ease the pressure on the external front. The progress in the real sector indicates that agriculture sector is set to perform better for the second year in a row. Production of all major Kharif crops, except maize, has surpassed the level of FY17. Similarly, large scale manufacturing (LSM) recorded a healthy broad-based growth of 7.2 percent during Jul-Nov FY18 as compared to 3.2 percent during the same period last year. Average headline inflation for H1-FY18 stands at 3.8 percent. Meanwhile, core inflation (non-food-non-energy) continued to maintain 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 together with a lagged impact of rupee depreciation and rising international oil prices are likely to increase inflation in the coming months.

On the external front, export receipts posted the highest growth in the last seven years of 10.8 percent in H1-FY18 against a reduction of 1.4 percent in H1-FY17. Workers’ remittances also recorded growth (2.5 percent) during the first half of the year as compared to a decline in 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 $2.6 billion since end June 2017 to reach $13.5 billion as of 19th January 2018.

It is relevant to point out here that four key factors of Pakistan’s economy have witnessed important changes since November 2017 impinging upon the monetary policy decision. Firstly, rupee has depreciated by around 5 percent. Secondly, oil prices are hovering near $70 per barrel. Thirdly, many central banks have started to adjust their policy rates upwards adversely affecting rupee interest- policy rate differentials vis-à-vis their currencies. Fourthly, multiple indicators show that the output gap has significantly narrowed indicating a buildup of demand pressures. Based on these developments, SBP has made a policy decision that is designed to balance growth and stability in the medium to long term.

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Mian Bilal