KARACHI: In order to curb aggregate demand and ensure near-term stability, the State Bank of Pakistan (SBP) Saturday has decided to increase the policy rate by 100 bps to 7.50 percent for the next two months effective from 16 July 2018.
The Monetary Policy Committee noted that the many factors are contributing to evolving economic challenges as the multiplier second half of FY18 is likely to offset the contractionary impact of monetary tightening in the recent months on domestic demand, higher international oil prices have continued to inflate the import bill, rising inflation projections and the ensuing fall in real interest rates and a notable reduction in Pakistani rupee and US interest rate differential.
The Central Bank in its first MPS for the Fiscal Year 2018-19 (FY19) said Pakistan has achieved a thirteen-year high growth rate of 5.8 percent in FY18 and the average CPI inflation was well below the 6.0 percent target. However, moving forward, the challenges to Pakistan’s economy have further accentuated.
Firstly, the provisional SBP estimate for fiscal deficit in FY18 is 6.8 percent as opposed to 5.5 percent estimated in May 2018. The current account deficit has also increased to $ 16.0 billion during July-May FY18 as opposed to $11.1 billion in the corresponding period last year.
This means that aggregate demand has proved to be higher than previously thought. Secondly, June inflation clocked in at 5.2 percent, and the average headline inflation for FY19 is expected to cross the 6.0 percent annual target. Thirdly, on the external front, though both exports and workers’ remittances are performing better, the sheer size of imports continues to pressurize FX reserves.
It said the real economic activity repeated its strong FY17 performance. However, towards the end of FY18, some challenges cast shadows on the capacity of the real sector to continue treading this high growth path. In the agriculture sector, the most important concern is shortage of water, which is likely to constrain agriculture production below the target in FY19. The manufacturing sector is also poised to show a mixed picture owing to high base some sector specific issues whereas construction allied industries are likely to perform at par. Taking stock of these developments and the spillover on the services sector, SBP projects FY19 GDP growth to be around 5.5 percent as compared to the annual target of 6.2 percent.
Turning to CPI, the average headline inflation for FY18 stands at 3.9 percent. However, this picture is changing rapidly as is visible from rising (YoY) headline and core inflation for June 2018 at 5.2 and 7.1 percent, respectively, SBP added.
Monetary expansion in FY18 has been driven by government borrowing for budgetary healthy growth in credit to the private sector. Despite some slowdown in fixed investment and particular issues of the sugar and fertilizer sectors, stock of private sector borrowing increased by Rs768 billion in FY18 which translates into a growth of 14.8 percent. In FY19, private sector is expected to increase by almost the same amount at a growth rate of about 13.0 percent. This will be driven primarily by the rise in need for working capital at the back of gestation of lagged fixed investment into production and rising exports.
The expansionary impact of net domestic assets (NDA) on broad money supply has been partially neutralized by net contraction in foreign assets of the banking sector. NFA saw a net contraction of Rs.793 billion percentage points on broad money growth during FY18.
