• Forecasts inflation between 18 and 20pc, GDP growth of 3-4pc this fiscal
• Policy rate now at 15pc after increase of 525bps in 2022

KARACHI: The State Bank of Pakistan (SBP) raised its key policy rate by 125 basis points to 15 per cent on Thursday in an attempt to cool the economy and tackle 13-year high inflation.

The latest rate hike takes the total increase to 525 basis points so far this year.

Most financial sector and other stakeholders were already anticipating a hike in the face of persistently high global energy prices, the abrupt ending of fuel subsidies and the need to control demand after the SBP said in its last policy statement the economy had rebounded much more strongly than anticipated.

The central bank has also linked the exports and long-term financing with the policy rate “to strengthen monetary policy transmission while continuing to incentivise exports by presently offering a discount of 500 basis points relative to the policy rate”, it said in the statement.

Linking the export finance scheme (EFS) and long-term financing facility (LTFF) to the policy rate will further reduce economic activity. The rate of EFS has been increased to 10pc from 7.5pc, whereas the rate of LTFF has been raised to 10pc from 7pc.

“This combined action continues the monetary tightening under way since last September, which is aimed at ensuring a soft landing of the economy amid an exceptionally challenging and uncertain global environment,” the central bank said.

Besides, the action should help cool economic activity, prevent a de-anchoring of inflation expectations and support the rupee amid high inflation and record imports, it said.

The SBP’s monetary policy committee (MPC) also forecast inflation between 18pc and 20pc and GDP growth between 3pc and 4pc for this fiscal year, below the 5pc target set in the annual budget last month.

“Despite the dampening effect of fiscal and monetary tightening on demand-pull inflation, inflation is likely to remain elevated around current levels for much of FY23,” the bank said.

Pakistan is wrestling with economic turmoil, a fall in reserves and a weakening currency. “The current account deficit is projected to narrow to around 3pc of GDP as imports moderate with cooling growth, while exports and remittances remain relatively resilient,” the bank said.

The country is in dire need of external funding to shore up its foreign reserves, which dropped by $493 million over the week to $9.82 billion on Thursday due to external debt and other payments.

Islamabad is in talks with the International Monetary Fund, and its latest review, if positive, would release a $1.85bn loan and open up other external financing options.

“We hope that we will reach a staff-level agreement with the IMF very soon,” SBP Acting Governor Murtaza Syed said after the rate announcement.

Pakistan entered the 39-month, $6bn IMF loan programme in 2019, but less than half of the amount has been disbursed so far as Islamabad has struggled to meet agreed targets.

The bank’s statement said that its monetary policy committee had noted three encouraging developments since the last meeting: first, the “unsustainable” energy subsidies were reversed and a budget centred on strong fiscal consolidation was passed; second, a $2.3bn commercial loan from China that shored up dwindling foreign exchange reserves; and third, the economic activity remained robust, with the momentum of the last two years of near 6pc growth carrying into the start of the new fiscal year.

Real sector

The bank said Pakistan’s strong economic rebound from Covid continued, with the level of output surpassing pre-pandemic levels, unlike in many other emerging markets.

“Most demand indicators suggest robust growth since the last MPC — sales of cement, POL [petroleum, oil, lubricants] and automobiles increased month-on-month — and growth in [large-scale manufacturing] remains high.

“Looking ahead, growth is expected to moderate to 3-4pc in FY23 on the back of monetary tightening and fiscal consolidation, helping to close the positive output gap and diminish demand-side pressures on inflation,” it said.

External sector

The SBP said that after moderating in the previous three months, the current account deficit rose to $1.4bn in May on the back of lower exports and remittances partly due to the Eid holidays.

It said that while non-energy imports had continued to moderate in the last three months, the decline had been more than offset by the significant increase in energy imports, which rose from $1.4bn in February to $3.7bn in June, both due to higher prices and volume.

“Without prompt additional measures to curtail energy imports — for instance through early closure of markets, reduced electricity use … and greater encouragement of work from home and carpooling — containing the trade deficit could become challenging,” the bank said.

“With such measures, the current account deficit is projected to narrow to around 3pc of GDP as imports moderate with cooling growth, while exports and remittances remain relatively resilient.”

Fiscal sector

Describing the FY22’s fiscal stance as “unexpectedly expansionary”, with the primary deficit estimated at 2.4pc of GDP, the SBP said this year’s budget targeted a primary surplus of 0.2pc of GDP on the back of significantly higher tax revenue.

However, it said it was important that the new taxation measures are progressive and “their burden should mainly be absorbed by the relatively better off while adequate protection is provided to the more vulnerable, for whom high food prices are a particular concern”.

Monetary and inflation outlook

The bank said that the private sector credit grew by a further 2pc month-on-month in May in nominal terms, driven by favourable developments in sectors like power, edible oil, construction-allied industries, as well as wholesale and retail trade.

“Demand for fixed investment and consumer loans also picked up, reflecting robust economic activity. Since the last MPC meeting, secondary market yields and cut-off rates in the government’s auctions have ticked up in the wake of the high inflation reading in June,” it said.

While forecasting inflation to remain between 18-20pc during FY23 before declining sharply during FY24, the SBP said this baseline outlook was subject to significant uncertainty, with risks arising from the path of global commodity prices, the domestic fiscal policy stance and the exchange rate.

“The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability and growth and will take appropriate action to safeguard them,” the statement said.

Published in Dawn, July 8th, 2022