Going far ahead of expectations, Pakistan’s central bank on Friday surprised the market by aggressively increasing the benchmark interest rate by a massive 1.5 percentage points to an 18-month high at 8.75%.
The move is aimed at curbing the accelerating inflation, controlling the widening current account deficit and supporting the rupee against the US dollar, the State Bank of Pakistan (SBP) said.
The central bank revised up its projections for inflation and current account deficit.
They are expected to remain elevated despite the latest policy rate-hike. They are estimated to slightly exceed the upper limits of the previous projected numbers for the current fiscal year 2022.
“Looking ahead, global commodity prices and potential further upward adjustments in administered prices of energy pose upside risks to the average inflation forecast of 7-9% in FY22,” read the latest Monetary Policy Statement (SPB) announced for one month.
“The current account deficit for FY22 is expected to modestly exceed the previous forecast of 2-3% of GDP [gross domestic product],” it added.
Market experts, after attending the central bank’s briefing on the latest monetary policy announcement, said the aggressive hike in the benchmark interest rate was not only aimed at cooling down the overheating economy, but apparently to fulfill International Monetary Fund’s (IMF) condition to resume the $6 billion loan programme as well.
The rate high would slow down economic activities in the next fiscal year if not in FY22.
The central bank, however, projected in the policy statement the economic growth would remain high close to upper side of the previously projected growth rate of 4-5% in FY22 on the back of continuous growth in agriculture production and industrial output.
The surge in the key policy rate would help the local currency to stabilise against the US dollar in the inter-bank market, as the real negative interest rate at around 2% caused domestic currency plunging to around Rs175 against the greenback against Rs152.27 in May.
Earlier, financial market experts had developed consensus for an increase of 75-100bps in the benchmark interest rate.
The SBP monetary policy committee (MPC) would meet again in December to review related development and take further actions, if required any.
Further aggressive monetary policy tightening cannot be ruled out. It might increase the policy rate by another 50-75 basis points in December and take it to 10% by June 2022, according to market experts.
“This [150bps increase in interest rate] reflected the MPC’s view that since the last meeting [in September], risks related to inflation and the balance of payments have increased while the outlook for growth has continued to improve,” the SBP statement read.
“With risks rotating from growth to inflation and the current account faster than expected, there is now a need to proceed faster to normalise the monetary policy to counter inflation and preserve stability with growth. Today’s rate increase is a material move in this direction,” it added.
“Looking ahead, the MPC reiterated that the end goal of mildly positive real interest rates remains unchanged, and given today’s move, expects to take measured steps to that end.”
Talking to The Express Tribune, National University of Sciences and Technology (NUST) Principal Dr Ashfaque Hasan Khan said the aggressive surge in the benchmark interest rate would accelerate inflation rather than controlling it. Besides, the action would compromise economic growth as well.
“Every one percentage point increase in the interest rate takes inflation higher by 1.3 percentage point,” he explained.
“Now, the economic growth would slow down to 3-5% against the government expectation for slightly over 5%.”
The NUST principal said the latest increase in the interest rate had added a burden of Rs270-300 billion on account of interest payment over the next one year.
The interest payment on external debt would further add up if the central bank opts to hike the rate further in future”
“The SBP has increased the interest rate on the dictation of the IMF to resume its loan programme,” he maintained.
“The rate hike would not only compromise economic growth, but also increase the rate of unemployment and contribute towards increasing poverty in the country.”
The SBP said in its monetary policy statement that the overall economic recovery appeared “increasingly durable and self-sustaining” against the backdrop of rapidly falling Covid-19 cases and the government’s vigorous vaccination roll-out.
“Looking ahead, rising input costs and normalisation of macroeconomic policies are likely to lead to some moderation in the growth of industrial activity. Nevertheless, this could be more than offset by the improved outlook for agriculture, such that risks to the growth forecast of 4-5% in FY22 are tilted to the upside,” it added.
Persistently high international commodity prices and strong domestic activity kept the current account deficit elevated at $3.4 billion in Q1-FY22.
The deficit widened to $1.66 billion in October from $1.13 billion in September due to high energy prices and an uptick in services imports, despite some moderation in non-energy imports.
“There was also a moderate month-on-month decline in exports and remittances,” the SBP statement read.
“Inflationary pressures have increased considerably since the last MPC meeting, with headline inflation rising from 8.4% (y/y) in August to 9% in September and further to 9.2% in October, mainly driven by higher energy costs and a rise in core inflation.”