The monetary policy committee is set to commence its next meeting on June 12th, 2023 and we expect the SBP to hold the policy rate at 21% in this meeting. To recall, in the last MPS in Apr’23, the State Bank of Pakistan (SBP) increased the benchmark policy rate by another 100bps to 21%, a record high. According to the SBP, while this decision was key to ensure price stability, it was also an important step towards anchoring inflation to the medium-term target.

Aggregate demand showing signs of weakness

The country’s central bank stands at a critical crossroad, faced with a choice that could shape the economic trajectory. With the interest rate already raised to a considerable level i.e. 21%, the question looms large—should they push it even higher? While the allure of curbing inflation is strong, treading cautiously might just be needed to preserve economic stability. High interest rate along with other macroeconomic measures have already put the brakes on economic growth, as evident from the recently released provisional GDP growth number of 0.29% for FY23. Sector-wise breakdown shows that the industrial sector in Pakistan encountered a negative growth of 2.94% (FY22: +6.83%) which can primarily be attributed to the impact of tight macroeconomic policies and higher cost of doing business, exerting downward pressure on aggregate demand. Therefore, the idea of further increasing interest rates would only raise risks to the overall growth and increase economic woes.

Addressing inflation holistically

While combating inflation is crucial, it is important to consider its underlying drivers. Inflationary reading of the past few months suggests that the pass through of higher taxes and duties, tapering off of untargeted subsidies, hike in food inflation post floods and exchange rate depreciation, became reflective in CPI, where a large jump was seen in food and energy components. Moreover, recently announced numbers for the month of May’23, where the headline inflation clocked-in at 38.0%, reaching historic high level too, suggests that pressure is mainly emanating from rising prices of food, clothing, energy and other household items. This said, second round impacts of the aforementioned are visible in core inflation, which has risen to 20% YoY in urban and 26.9% in rural baskets. We believe, further raising interest rates may not effectively address the root causes of rising inflationary pressure and therefore, adopting a holistic approach would be required to ensure a well-rounded strategy.

Courtesy- AHL Research