SBP ends low interest rates to fight inflation

ANALYSIS

The State Bank of Pakistan has just ended its 21-month long saga of a low interest rate of 5.75 per cent, raising it to six per cent, as it is going to fight an uptick in inflation unleashed by depreciation of its rupee. Four factors led SBP to make the hike: “The Pakistani rupee has depreciated by around five per cent, imported international oil pries are hovering near $70 per barrel, a number of central banks have started to adjust their policy rates upward and the fact that it is adversely affecting the Pakistani rupee interest rate differential vis-à-vis their currencies.”

“Multiple indicators show that the output gap has significantly narrowed, indicating a build-up of demand pressures,” it added.

In its determination to raise industrial output and gear up businesses all around, the SBP kept the benchmark interest rate at 5.75 per cent for the last 21 months, or since May 2016. At this level, the rate was at a 43-year low. Pakistani industry and business had fought atrocious rates of as high as 17 per cent previously. That constantly hit industrial output and made Pakistani products uncompetitive internationally. And there are four more good news. One, home remittances of Pakistani workers rose 2.5 per cent in the first half of FY-18 over the same period of FY-17.

Two, exports’ growth touched a sevenyear high of 10.8 per cent in the first half of FY-18, compared to a drop of 1.4 per cent in the same period of FY-17. The Pakistan Bureau of Statistics reports that exports in the July-December FY-18 period rose to $6.64 billion, compared to $6.15 in the same period of FY-17.

Three, there are hot favourites in future growth. Investments relating to the China-Pakistan Economic Corridor (CPEC), construction and its allied industries will “maintain their higher growth momentum”. Larger FDI inflows are projected for CPEC-related projects and others.

Four, the SBP projects GDP growth for FY-18 at 5.8 per cent, higher than the 5.3 per cent in FY-17,but less than the targeted six per cent. The bank reports the the current account deficit, which widened 1.6 times to $7.4 billion in the first half of FY-18, will be reduced by a larger inflow of home remittances sent by Pakistanis working in other countries, besides larger FDI inflows, rising exports, as well as more official aid flows. The SBP’s liquid forex reserves as at January 19, were $13.5 billion.

The SBP listed four key elements that led it to make an upward revision in the benchmark interest rate. These elements appeared on the business scene since in November 2017, while the new government of Prime Minister Shahid Khaqan Abassi was trying to settle down in the saddle, on the back of the highly-debatable removal of pro-business former prime minister Nawaz Sharif. The controversy, surrounding Sharif may persist until July 2018, when elections of the national parliament will be held.

SBP Governor Tariq Bajwa, explaining the policy rate statement said: “We have made an exchange rate correction in one go to bring stability in the forex market. It is the right time to make a policy decision that will balance growth and stability in the medium to long term in order to pre-empt an overheating of the economy and inflation breaching its target rate.”

What is the worrying thought? It’s the rising trajectory of inflation that has hit the middle and lower-middle class. Bajwa confirms it: “The average headline inflation remains within the forecast range of six per cent, but the core inflation has continued to rise.” In July-December FY-18, it was at 3.8 per cent.

What will be the actual impact of the new monetary policy, the bank rate increase and the fate of the rupee? It will be known in the weeks to come. Everyone is waiting to see it.