FeaturedNationalVOLUME 18 ISSUE # 02

Boosting the borrowing cost

The State Bank of Pakistan’s decision to hike the policy rate aims at containing rising inflation and appeasing the International Monetary Fund. Though not expected by the market, the step will bring stability on internal and external fronts.

The policy rate has been hiked by 100 basis points to a 24-year high of 16pc after maintaining it in its last two monetary policy committee meetings in August and October. It also shows harmony between the central bank and the finance ministry, headed by Isahq Dar, who supports low interest rates to boost economic activity in the country and a stronger rupee against the dollar to check price hikes. The decision will also pave the way for discussions with the IMF for the release of its $1b tranche.

Justifying its decision, the SBP said the hike “aimed at ensuring that elevated inflation does not become entrenched”. According to the SBP monetary policy committee (MPC), inflationary pressures have proven to be stronger and more persistent than expected. SBP Governor Jameel Ahmad said the tightening so far was enough to achieve its current objectives. The SBP said inflation was likely to be more persistent than previously anticipated, “it is still expected to fall towards the upper range of the 5-7 per cent medium-term target by the end of FY24, supported by prudent macroeconomic policies, orderly rupee movement, normalising global commodity prices and beneficial base effects”.

“Maintaining fiscal discipline is needed to complement monetary tightening, which would together help prevent an entrenchment of inflation and lower external vulnerabilities,” it said. The headline inflation measured by the consumer price index (CPI) rose to 26.6pc year-on-year in October after devastating floods and attempts to maintain the fiscal discipline that have slowed the economy. “The rise in cost-push inflation cannot be overlooked and necessitates a monetary policy response. The MPC noted that the short-term costs of bringing inflation down are lower than the long-term costs of allowing it to become entrenched,” the SBP said. Since the last meeting in September, the MPC noted three key domestic developments. First, headline inflation increased sharply in October. “Food prices have also accelerated significantly due to crop damage from the recent floods, and core inflation has risen further,” it said.

Second, a sharp decline in imports led to a significant moderation in the current account deficit in both September and October. “Despite this moderation and fresh funding from the Asian Development Bank, external account challenges persist,” said the SBP.

Third, “after incorporating the Post-Disaster Needs Assessment of the floods and latest developments, the FY23 projections for growth of around 2pc and a current account deficit of around 3pc of GDP shared in the last monetary policy statement are re-affirmed,” it said. However, it said that higher food prices and core inflation were now expected to push average FY23 inflation up to 21-23pc.

The rate of inflation, which has been rising relentlessly for the sixth consecutive week, rose by 0.48pc week-on-week, while the year-on-year inflation hit 30.16pc for the week that ended on November 24. The hike was mainly due to a surge in the prices of essential food items, including onions, tomatoes and pulses. According to data released by the Pakistan Bureau of Statistics (PBS), the prices of 19 items increased, nine items decreased while 23 items remained stable during the week. In terms of year-on-year, a spike of 64.57pc and 54.71pc was witnessed in the costs of diesel and petrol respectively.

In the past few months, inflation in the country reached peaks, not seen in many decades due to a steep hike in international commodity prices and the rupee’s depreciation. Besides, the government withdrew subsidies on fuel and electricity under an agreement with the IMF. The recent floods damaged standing crops, which added to the suffering of the common people.

On the other hand, foreign exchange reserves held by the central bank fell by 1.68pc on a week-on-week basis, according to the SBP. On November 18, the foreign currency reserves held by the SBP were $7,825.7 million, down by $134 million compared with $7,959.5 million on November 11. According to the central bank, the decrease in reserves came due to external debt repayment. Overall, the liquid foreign currency reserves held by the country, including the net reserves held by banks other than the SBP, stood at $13,645 million. Net reserves held by banks amounted to $5,819.3 million. In the week ended August 27, 2021, the foreign exchange reserves held by the central bank soared to an all-time high of $20.15 billion after Pakistan received the general allocation of Special Drawing Rights (SDRs) worth $2.751 billion from the International Monetary Fund (IMF) on August 24.

The central bank has reaffirmed its projection for the current account deficit to narrow down to 3pc, or around $10 billion of gross domestic product (GDP) for the current fiscal year. The deficit had soared to 4.6pc of GDP in the previous fiscal year ended June 30, 2022. In absolute terms, the deficit had hit a second historical high of $17.4 billion in FY22.

It is obvious that the government will have to make decisions according to the needs of the country, not keeping in view political considerations. Pakistan’s economic policies have been dictated by considerations for political gains in the past. It is good to see policies are being made keeping in view national interests and without caring for political loss. They will pay in the end.