SBP policy rate
Against market expectations, the State Bank of Pakistan has left the key interest rate unchanged at 6% for the next two months, arguing that the recent rupee devaluation would manage to offset external pressure on the economy. The move comes as a surprise to market followers and analysts who expected an interest-rate hike after the rupee underwent a second massive round of devaluation last week. The development took the overall plunge of the rupee to over 9% against the US dollar in the last three months, stoking fears of inflation and a corresponding hike in the interest rate. In the last monetary policy statement in January, the SBP's policymakers raised the policy rate by 25 basis points to six percent as a preemptive measure to overcome growing economic challenges. The central bank had maintained the policy rate at 5.75 percent for 20 months
The benchmark rate determines the cost of overnight funds in the money market. The central bank uses it as a tool to control money supply in the economy and manage both economic growth and inflationary trends. On March 20, rupee depreciated 4.43 percent to 115 against the US dollar. Balance of payments continued to weaken. The country's current account deficit widened 50 percent to $10.826 billion in the first eight months of the current fiscal year of 2018. In a statement the SBP has said that some time should be allowed for the impact of recent policy developments to unfold.
Most analysts expected the central bank to increase the rate by 25-50 basis points. Their expectation was based on the fact that inflation was building up amid rising petroleum prices. But the central bank seems to have given more weight to the prospects of higher economic growth going forward: a low interest rate is supposed to spur economic activities as businesses borrow more when the cost of funds is down. The SBP statement noted: "The prospects of achieving an eleven-year high growth rate remains strong with average headline inflation within comfortable bounds for 2017-18 and 2018-19,"
Acknowledging the dangers that high current account and fiscal deficits pose, the SBP pointed out that the trend can affect mediumterm economic stability. However, recent adjustments stemming from greater exchange rate flexibility, active monetary management as well as visible improvements in exports and remittances are expected to bear fruit for the medium term in terms of sustaining the growth momentum without posing a risk to stability.
It is relevant to mention here that the central bank let the rupee lose 4.4 per cent value against the dollar a couple of weeks back. The move was aimed at making exports competitive in the international market while curbing the growing trend in imports. But the impact of the devaluation appears on the trade balance with a lag, which is why the SBP decided to maintain the status quo for the time being. Yet analysts believe that an increase in the key interest rate is inevitable. According to some experts, the decision to maintain the status quo was on the back of subdued inflation. According to them, the policy decision seems to be precautionary before making any abrupt changes. It is estimated that there will be a hike of 1 per cent in 2018 (calendar year) on the back of a weakened rupee, widening current account gap, expectation of higher inflation in coming months and growing consumer spending.
The SBP has said financing the high current account deficit is a challenge. A healthy growth in foreign direct investment and higher official inflows were insufficient to completely finance the current account deficit. The SBP has also hinted at shoring up foreign exchange reserves and anchoring sentiments in the forex market through external inflows.