State Bank keeps policy rate intact at 7%
Recently Topline Research conducted a poll of key financial market participants regarding monetary policy. A total of 62 participants took part in the poll, compared to 78 in the May 2021.
According to the Monetary Policy Committee, since its last meeting in May, it was encouraged by the continued domestic recovery and improved inflation outlook; following the recent decline in food prices and core inflation.
In addition, the consumer and business confidence have risen to multi-year highs and inflation expectations have fallen. As a result of these positive developments, the growth is projected to rise from 3.9 per cent in FY21 to 4 per cent to 5 per cent this year, and an average inflation to moderate to 7 per cent to 9 per cent from its recent higher out-turns.
Imports are expected to grow on the back of the domestic recovery and rebound in global commodity prices, albeit more moderately than in FY21.
The Monetary Policy Committee noted the market-based flexible exchange rate system, resilience in remittances, an improving outlook for exports, and appropriate macroeconomic policy settings should help contain the current account deficit in a sustainable range of 2 per cent to 3 per cent of GDP in FY22.
Notwithstanding this moderate current account deficit, the country’s foreign exchange reserves position is expected to continue to improve this year due to adequate availability of external financing.
Against this backdrop, the committee felt that the uncertainty created by the ongoing fourth wave of the Covid in Pakistan and the global spread of new variants warrants a continued emphasis on supporting the recovery through accommodative monetary policy.
Looking ahead, in the absence of unforeseen circumstances, the committee expects the monetary policy to remain accommodative in the near-term, and any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates over time.
If signs emerge of demand-led pressures on inflation or of vulnerabilities in the current account, the committee noted that it would be prudent for the monetary policy to begin to normalise through a gradual reduction in the degree of accommodation.
This would help ensure that inflation does not become entrenched at a high level and financial conditions remain orderly; thereby, supporting sustainable growth.
The Monetary Policy Committee considered key trends and prospects in the real, external and fiscal sectors, and the resulting outlook for monetary conditions and inflation.
Pakistan’s economic recovery continues, driven by industry, particularly large-scale manufacturing and construction, and services.
Several high-frequency indicators show strong year-on-year growth, including fast moving consumer goods (FMCG) sales, steel production, cement sales, POL sales, and electricity generation.
The recent month-on-month deceleration witnessed in some indicators is mainly seasonal, and in the case of automobile sales was compounded by delayed bookings in anticipation of supportive measures in the FY22 budget.
Notwithstanding the upswing in activity, the capacity utilisation in manufacturing is still below its peak levels during FY16/18 and the services sector activity has not yet fully returned to normal due to the intermittent mobility restrictions, it added.
The Monetary Policy Committee also noted that in FY22, growth is expected to pick up further, supported by measures announced in the budget, accommodative monetary conditions, and disbursements under the SBP’s Temporary Economic Refinance Facility (TERF) for investment and other refinance facilities.
The key budgetary measures included increased development spending and reduced regulatory duties, custom duties, federal excise duty and sales tax on the import of raw materials and capital goods.
These measures will directly benefit construction and allied industries, as well as export-oriented industries, it said, adding that the agricultural growth is also expected to contribute favourably, despite reported water shortages at the start of the sowing period of Kharif crops.
The key downside risk to growth stems from the resurgence of the Covid cases associated with the new strains of the virus, both globally and domestically, amid still-low vaccination rates.
On the external front, the Monetary Policy Committee noted that after recording surpluses in the initial months, the current account deficit widened in the second half of FY21, reflecting the pick-up in domestic activity, as well as seasonality in import payments, higher global commodity prices, and vaccine imports.
In addition, imports of capital goods rose, reflecting the improvement in the investment outlook of the economy. Largely in line with other emerging market currencies, the rupee depreciated by around 4 per cent since the last Monetary Policy Committee meeting, partly as expectations of normalisation of the monetary policy in the United States have been brought forward.
For FY21 as a whole, the Monetary Policy Committee noted Pakistan’s external position was at its strongest in several years. In line with the central bank’s projections in March 2021, the current account deficit fell to only 0.6 per cent of GDP. This is the lowest current account deficit in 10 years, supported by an all-time high exports and remittances.
The SBP’s forex reserves rose $5.2 billion during FY21 to end at over $17 billion, or around three months of imports, a 4½ year high.
Moreover, the SBP’s net external reserve buffers (gross reserves less forward liabilities) have risen by $14.1 billion since the beginning of FY20.
The committee said there were good reasons to expect that, unlike several previous growth upturns in Pakistan, the current economic recovery would be accompanied by external stability.
Given the expected resilience in remittances and an improving outlook for exports, the current account deficit is expected to converge towards a sustainable range of 2 per cent to 3 per cent of GDP in FY22.
This is much lower than in FY17 and FY18, when the current account deficit increased to around 4 per cent and 6 per cent of GDP, respectively, and the forex reserves fell $2 billion and $6.4 billion, respectively.
Moreover, imports this year are expected to be more skewed towards machinery rather than consumption, compared with FY17, and the machinery imports are projected to be better distributed across sectors than in FY18, when power and telecommunications dominated.
With the contained current account deficit and healthy commercial, official, portfolio and FDI inflows, Pakistan’s external financing needs of around $20 billion are expected to be more than fully met in FY22, it noted, adding that as a result, the foreign exchange reserves are projected to rise further.
Since September 2020, the State Bank’s Roshan Digital Account initiative for overseas Pakistanis has generated new financial inflows of $1.8 billion. In July, Pakistan successfully raised an additional $1 billion through the issuance of its Eurobond that fetched $2.5 billion in March.
In August, the country’s reserves buffer are expected to rise another $2.8 billion through the IMF’s planned new global SDR allocation.
In the event of an unforeseen shock, for instance higher-than-expected oil prices or capital flight from the emerging markets due to a tightening of financial conditions in advanced economies, the Monetary Policy Committee noted the market-based flexible exchange rate and improved outlook for domestic investment would help keep the balance of payments position sustainable.
In addition, if the balance of payments pressures were to emerge, some normalisation of monetary policy may also be needed, especially if demand-side pressures are at play.
On the fiscal front, the FY22 budget is expected to be broadly inflation-neutral, as most tax rates have been left unchanged.
The government expects the budget deficit to decline from 7.1 per cent of GDP last year to 6.3 per cent in FY22 on the back of strong growth in both tax (24.6 per cent y-o-y) and non-tax revenue (24.7 per cent), mainly from the income and sales tax, as well as the petroleum development levy.
This higher revenue is expected to offset a significant growth in both development (71 per cent for federal and provincial governments) and non-interest current expenditure (12.8 per cent, mainly in the form of subsidies and grants).
Meanwhile, the government projects public debt to decline further from 87.60 per cent of GDP in FY20 and 83.10 per cent in FY21 to 81.80 per cent in FY22.
The Monetary Policy Committee noted it would be important to carefully monitor how fiscal out-turns evolve through the year, and their resulting implications for the growth and inflation outlook.
The committee also said the financial conditions remain appropriately accommodative, with the market yields and benchmark rates broadly unchanged.
The private sector credit continues to recover primarily due to the low interest rate environment and the SBP’s support measures during the Covid pandemic.
In FY22, the private sector credit is expected to grow broadly in line with the nominal GDP and the central bank stress-tests indicate that the banking sector should remain stable even under adverse scenarios, with system-wide non-performing loans contained and capital adequacy well above the domestic regulatory benchmark.
Similarly, inflation fell from 11.1 per cent (y-o-y) in April to 9.7 per cent in June. For the first time since January, the food prices fell on a month-on-month basis in June on the back of the government’s administrative measures and imports of wheat and sugar.
Despite the rise in global oil prices, downward adjustments in the petroleum development levy have helped limit domestic pass-through.
Moreover, core inflation also fell over the last two months in both urban and rural areas, confirming the view that the energy and food-driven inflation highlighted in recent monetary policy statements has not seeped into general prices and that inflation expectations are well-anchored.
The average inflation in FY21 was 8.9 per cent, in line with the SBP’s forecast range announced in May 2020. This is the third consecutive year that inflation has fallen within or marginally below the projected range issued by the central bank around the beginning of the year, highlighting strong forecasting performance.
In addition, this outcome underscores the key role that the State Bank of Pakistan forecast range is increasingly playing in anchoring inflation expectations; thus, allowing the monetary policy to credibly look through temporary inflationary pressures.
The recent decline in inflation is consistent with the Monetary Policy Committee’s view that recent price pressures are largely supply-driven and transient.
The headline inflation should begin to dissipate more visibly in the second-half of the year when the February electricity tariff increase drops out of the base, converging to the 5 per cent to 7 per cent target range over the medium-term.
The key risk that could lower inflation is a resurgence in the pandemic, domestically and globally. Conversely, risks that could raise inflation included higher-than-expected global commodity prices, especially if these are coupled with upward adjustments in the PDL or domestic energy tariffs, as well as fiscal slippages that lead to stronger demand-side pressures through the year.
The Monetary Policy Committee will continue to carefully monitor developments affecting the medium-term prospects for inflation, financial stability and growth and will be prepared to respond appropriately, as and when required.
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