The State Bank of Pakistan (SBP) on Tuesday raised its main policy rate by 100 basis points on Tuesday to 13.25%, citing increased inflationary pressures and a likely near-term rise in prices from higher utility costs.
The increase follows this month’s accord with the International Monetary Fund (IMF) on a $6 billion loan package that comes with tough conditions aimed at cutting Pakistan’s substantial fiscal and current account deficits and bolstering its shrinking currency reserves.
SBP Governor Reza Baqir said the decision to raise rate took into account upside inflationary pressures and the impact from recent increases in utility prices passed under the government’s recent budget. He said the central bank’s Monetary Policy Committee (MPC) stood ready to act on unexpected developments that could prompt either further modest tightening or easing in monetary policy. But the latest rise had completed the necessary policy measures to address longstanding imbalances.
“With this decision on interest rates, the MPC is of the view that the adjustment related to interest rates and the exchange rate from previously accumulated imbalances has taken place,” the committee said in a statement.
The central bank has now increased its main policy rate nine times since the beginning of last year, raising it by a total of 750 basis points as it has struggled to control inflation, a widening fiscal deficit and pressure on the rupee.
Inflation eased slightly last month to 8.9% but Baqir said he expected pressures to continue with inflation averaging 11-12% in the current fiscal year, higher than previously expected, before falling considerably in 2021.
“If you look at the time-path of this inflation, in the next few months, due to one-time factors, inflation will be higher. These have been accounted for [in our projections]. In the second half of the fiscal year, according to our projections, inflation will be lower. By the start of the next fiscal year, there will be a noticeable decrease in inflation,” he said.
“The rate hike will benefit people who have parked savings in saving accounts at banks and/or in national saving schemes,” he said. “The interest rate hike will help control dollarisation in the economy. People will prefer to keep savings in rupee rather than in dollars.”
The SBP, which forecast real gross domestic product (GDP) growth of about 3.5 percent in the year to June 2020, said real interest rates implied by these inflation projections and Tuesday’s rate rise were “at appropriate levels considering the cyclical weakening of aggregate demand”.
Under the bailout accord, the IMF said it expected “appropriately tight monetary policy” would bring inflation down to 5-7% in the medium term. With slowing growth, a budget deficit that has climbed to more than 7% of GDP and currency reserves of about $8 billion following the first tranche of the IMF loan, Pakistan has been struggling to ward off a debt and balance of payments crisis for more than a year. After initial reluctance, Prime Minister Imran Khan’s government turned to the IMF for support and finalised a $6 billion loan agreement this month that will unlock an additional $38 billion in loans from other international partners. The three-year agreement for Pakistan’s 13th IMF bailout since the late 1980s, has seen a sharp drop in the value of the rupee that has added to inflationary pressures after the central bank agreed to a “flexible, market-determined exchange rate”. However, the SBP said it stood ready to take action to address any “disorderly market conditions” in the foreign exchange market.
