SBP expected to jack up policy rate by 100bps in next review: ABL

The central bank had increased policy rate by 300bps to 20 per cent this month

KARACHI (Web Desk) - The State Bank of Pakistan (SBP) is likely to increase the interest rates further in the upcoming policy review in April to fight the mounting inflation, a brokerage firm predicts.

In a note, Arif Habib Limited (AHL) states that the monetary policy committee is set to commence its next meeting on April 4 and the firm expect the SBP to raise its policy rate by 100 bps (basis points) to 21 per cent in this meeting.

The company conducted a survey (poll) to find out what the market is expecting in the upcoming monetary policy by taking feedback from various sectors.

According to the survey poll results, 57.7pc of the total respondents are of the view that the SBP will increase the policy rate, of which: 30.8pc are expecting a rate hike of 100bps, 26.9pc are foreseeing a rate hike of 200bps.

However, 42.3pc of the total respondents are of the view that policy rate will remain unchanged at 20pc.

The central bank jacked up the policy rate by a whopping 300bps to 20pc this month. As per the Monetary Policy Committee, the decision was taken on inflation risks. Due to external and fiscal adjustments, the risks that were identified in the previous policy meetings, had materialised and become partially visible in the consumer price index (CPI) numbers.

Moreover, the MPC also revised its CPI forecast for the year to 27-29pc against earlier forecast of 21-23%.

“Inflation in the upcoming months is likely to remain elevated as the impact of external and fiscal adjustments (including additional taxation, tariff hikes, weakening of currency and ‘Ramazan factor’) unfolds,” the AHL said.

“The average inflation for 8MFY23 clocked-in at 26.2pc compared to 10.5pc in the same period last year. Core inflation continues to creep higher each month as inflationary pressures rise and broaden, reflecting the spill over effects of the PKR weakening amid ongoing debt repayments and lower financial inflows,” it added.

Since the last monetary policy announcement in March, the rupee has lost 1.2pc of its value against the dollar. These external account challenges persist despite significant contraction in the current account deficit, recorded at $242 million in January (lowest since March 2021) mainly on the back of lower imports, down 38pc YoY with the measures taken by the authorities to curb import along with decline in international commodity prices.

“Besides controlling inflationary pressure, the decision to raise the policy rate will also facilitate the long-awaited ninth review with the IMF, which is crucial for Pakistan to receive tranche of USD 1.2bn and unlock further inflows from other international creditors,” it said.

The market’s reaction to surging inflation is evident from the recent rise in bond market rates, which has been driven by investors’ bullish outlook.

In latest March 8, 2023 Market Treasury Bills (T-Bill) Auction, the cut-off yields of three-month, six-month and 12-month tenor increased by 105bps, 95bps and 120bps compared to the previous auction. With the data available since June 1998, yields in all three tenors are at their historic high levels.

Moreover, if “we look at the shape of the yield curve to extrapolate markets’ expectations for monetary policy, we see that the secondary market yields since the last monetary policy of March 2023 too, have increased to 20.93pc”.

According to AHL, it can be safely assumed that the market too expects the central bank to up the policy rate in the upcoming policy. 

-- SBP raises key interest rate by 300bps, takes it to 20pc --

Bowing down to another demand of International Monetary Fund (IMF), the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) announced an interest rate hike of 300 basis points, taking it to 20%. This is the highest level of the key policy rate since October 1997.

“At its meeting held on 2nd March 2023, the MPC decided to increase the policy rate by 300 basis points to 20%,” it said in a statement, in which it also announced moving the next MPC meeting to April 4 from April 27.

“During the last meeting in January, the Committee had highlighted near-term risks to the inflation outlook from external and fiscal adjustments. Most of these risks have materialised and are partially reflected in the inflation outturns for February. The national CPI inflation has surged to 31.5 percent y/y, while core inflation rose to 17.1 percent in urban and 21.5 percent in rural basket in February 2023.”

The MPC statement said that in today’s meeting, the committee noted that the recent fiscal adjustments and exchange rate depreciation have led to a significant deterioration in the near term inflation outlook and a further upward drift in inflation expectations, as reflected in the latest wave of surveys.

“The Committee expects inflation to rise further in the next few months as the impact of these adjustments unfolds before it begins to fall, albeit at a gradual pace.

“The average inflation this year is now expected in the range of 27 - 29 percent against the November 2022 projection of 21 – 23 percent. In this context, the MPC emphasised that anchoring inflation expectations is critical and warrants a strong policy response.”

On the external side, the MPC noted that despite a substantial reduction in the current account deficit (CAD), vulnerabilities continue to persist.

“In January 2023, the CAD fell to $242 million, the lowest level since March 2021. Cumulatively, the CAD – at $3.8 billion in Jul-Jan FY23 – is down 67 percent compared to the same period last year. Notwithstanding this improvement, scheduled debt repayments and a decline in financial inflows amid rising global interest rates and domestic uncertainties, continue to exert pressure on FX reserves and the exchange rate.”

The MPC noted that FX reserves remain low and concerted efforts are needed to improve the external position. In this regard, conclusion of the ongoing 9th review under the IMF’s EFF will help address near-term external sector challenges. Furthermore, the MPC stressed on the urgent need for energy conservation measures to alleviate pressure on the external account and meet the import requirements of other sectors.

“Recent fiscal measures – including an increase in GST and excise duties, reduction in subsidies, adjustments in energy prices, and the austerity drive – are expected to help contain the otherwise widening fiscal and primary deficits. As highlighted in earlier statements, the envisaged fiscal consolidation is critical for economic stability and will complement the ongoing monetary tightening in bringing down inflation over the medium-term.”

The Committee emphasised that any significant fiscal slippages will undermine monetary policy effectiveness in the context of achieving the price stability objective.

The MPC also assessed the impact of further monetary tightening on financial stability and the near-term growth outlook.

“The Committee views that the risks to financial stability remain contained, given that financial institutions are broadly well capitalised. On growth, however, there exists a trade-off. The MPC, nonetheless, reiterated its earlier view that the short-term costs of bringing down inflation are lower than the long-term costs of allowing it to become entrenched.

“Barring unexpected future shocks, the MPC noted that today’s decision has pushed the real interest rate in positive territory on a forward-looking basis. This will help anchor inflation expectations and steer inflation to the medium-term target of 5-7 percent by end FY25.” 

IMF demand

Earlier on Thursday, the International Monetary Fund (IMF) had stressed upon Pakistan to tighten its monetary policy and enhance interest rate.

The demand came at a virtual meeting held between Pakistan and the IMF. IMF officials reviewed efforts made by Pakistan to complete the staff level agreement.

Sources told Dunya News that Pakistan has been facing pressure to implement on the Fund's requirements through advance measures in time.

They said tightening the monetary policy is likely to increase interest rates. The State Bank of Pakistan's base interest rate is currently 17 per cent while the IMF is calling for another 2pc increase in interest rates.

The IMF is pushing for a tightening of monetary policy based on inflation.

According to the sources, Pakistan side informed the IMF about the previous measures, gave a briefing on the financing of friendly countries, and China's refinancing decision of $700 million.

Sources further said the IMF was also briefed on the financing of $1.2 billion from the United Arab Emirates, in addition to the financing through shares in the stock market of the UAE and Qatar.

During the virtual meeting, Pakistan also presented its foreign exchange reserve target strategy till June.