In the monetary policy meeting held today (25th Nov’22), the State Bank of Pakistan (SBP) has hiked the benchmark policy rate by 100bps to 16%. To recall, the last hike of 125bps was done in Jul’22. The current stance aims to contain the impact of elevated domestic inflationary pressure, so as to embark on a path of sustainable recovery.
Three key observations since the last MPC:
The MPC highlighted the following developments since the meeting in Oct’22.
Firstly, global and domestic supply shocks have increasing pushed CPI higher. These have spilled over in broader prices and wages (cost-push), and upstretched inflation expectations while also undermining medium-term growth. Headline inflation rose sharply in Oct’22 by 3.5% to 26.6% YoY driven by a normalization of fuel cost adjustments in electricity tariffs, and higher food prices.
Crop damage post recent floods has increased food prices by 35.7% YoY, and core inflation to 18.2% YoY. It remains pertinent to curb food inflation through administrative controls and necessary imports.
Inflation expectations of the MPC for FY23 revised up to 21-23% from 18-20% previously.Secondly, external account challenges persevere despite a sharp cut in imports in Sep’22 and Oct’22, as well as fresh funding from the ADB.
Lastly, projections for GDP growth of 2% and CAD of 3% of GDP for FY23 shared in the last policy have been maintained after incorporating the Post-Disaster Needs Assessment of the floods.
Other observations
Economic activity as measured through demand indicators showed a double-digit decline on a YoY basis in Oct’22 since the last MPC meeting on the back of “disruptions from floods and on-going policy and administrative measures.”
Electricity generation declined for a fifth straight month, down 5.2% YoY.
Although export-oriented sectors contributed positively, LSM remained flat against last year.
Factors that will keep the GDP growth tepid include sizeable damage to rice and cotton crop, as well as slow growth in the manufacturing and construction sectors.
§ CAD during 4MFY23 fell to USD 2.8bn, almost half of the levels seen in the same period of last year. This was attributable to a 11.6% dip in imports to USD 20.6bn coupled with a 2.6% jump in exports to USD 9.8bn.
Albeit, remittances compressed by 8.6% to USD 9.9bn, “reflecting a widening gap between the interbank and open market exchange rate, normalization of travel and US dollar strengthening.”
Net inflows on the financial side dropped to USD 1.9bn during 4MFY23 vs. USD 5.7bn last year amid domestic uncertainty and tighter global financial conditions as major central banks are adopting rate hikes.
CAD is projected to remain moderate in FY23 as augmented imports of cotton and lower exports of rice and textile are expected to be offset by a continued slide in impost in lieu of economic slowdown and softer global commodity prices.
With the materialization of anticipated external flows from bilateral and multilateral sources, a gradual improvement is expected in FX reserves.
Pressure on the current account could further lose steam if there is a notable decline in global oil prices or “the pace of rate hikes by major central banks slows.”
Fiscal outcomes deteriorated in 1Q relative to last year, despite the budgeted consolidation, with fiscal deficit arriving at 1% of GDP compared to 0.7%, and primary surplus shrinking to 0.2% of GDP from 0.3%. This was primarily due to a decline in non-tax revenue and augmented interest payments. Simultaneously, growth in FBR’s tax revenues more than halved in 4MFY23.
Several relief measures are being executed for the agriculture sector such as mark-up subsidies for farmers and the provision of subsidized inputs, in response to the floods. While it will be pertinent to minimize fiscal slippages by re-routing expenditure and foreign grants to meet additional needs, the floods certainly pose a threat to the aggressive fiscal consolidation budgeted this year.
Fiscal discipline complemented by monetary tightening will help prevent an entrenchment of inflation, and lower external vulnerabilities.
Private sector credit offtake also showed moderation, increasing by just PKR 86.2bn in 1Q against PKR 226.4bn last year, given lower working capital loans to wholesale and retail trade services, and textile sector amid reduced cotton output, as well as slowdown in consumer finance.
Medium-term target for inflation is the upper range of the 5-7% by the end of FY24, “supported by prudent macroeconomic policies, orderly Rupee movement, normalizing global commodity prices and beneficial base effects.”
Courtesy- AHL Research