The State Bank of Pakistan (SBP), to everyone’s surprise, on Thursday, September 14, announced that it would keep the interest rate unchanged at 22%. The markets had anticipated a hike of around 2% due to recent events, including rising oil and power prices, and high currency volatility.
However, the central bank's decision was based on its expectation that inflation would decrease in the coming months, resulting in positive real interest rates. This expectation was derived from recent administrative measures to combat illegal activity in currency and commodities markets, as well as improved agricultural output.
“SBP has taken into account softening inflation expectations and the reversal of the rupee due to a crackdown on speculation to hold rates. Inflation is expected to start declining significantly from November 2023. The current account seems to be in control at the current PKR parity and agricultural output along with a reopening of imports should boost LSM,” remarked Yousuf Farooq, Head of Research at Chase Securities.
However, the SBP's expectation regarding the medium-term inflation outlook has consistently proven to be incorrect over the past two years. This raises a serious question about its ability to effectively manage the situation.
Some quotes from the @StateBank_Pak about its medium-term inflation outlook:
— Uzair Younus عُزیر یُونس (@UzairYounus) April 4, 2023
January 2020: “The MPC also viewed the current monetary policy stance as appropriate to bring inflation down to the medium-term target range of 5 – 7 percent over the next six to eight quarters.”
As per Bloomberg, in August, Pakistan experienced a decrease in inflation, but it is expected to rise again, led by the increase in energy prices and a decline in the value of the rupee. The government is doubling down on power and gas tariff hikes as part of the IMF program, but this has resulted in higher living expenses. It is anticipated that inflation will average around 30% in the final four months of this year.
Source: Tellimer
As per a report by Tellimer, “Food and fuel exposure of household spend and imports are most acute in Bangladesh, Jordan, Lebanon, Pakistan, Philippines.”
However, according to Mustafa Pasha, Chief Investment Officer at Lakson Investments, SBP's decision to keep the interest rate unchanged may not necessarily be a bad idea. This is because the government is already implementing fiscal consolidation measures through higher taxation and levies, and this might not be the ideal time to double down on that through monetary tightening given that the private sector credit has already been choked out and the impact of a hike would be increased debt servicing cost for the government, leading to a higher fiscal deficit.
Pasha also reiterated that the stock market players were anticipating a rate hike and would react positively to the news. However, it's important to note that while this might lead to a short-term upward movement in equities, a sustained rally will depend on the flow of dollars and the adherence to the IMF reform agenda. This is crucial to avoid any concerns or uncertainties in the disbursement of the IMF loan tranche scheduled for 1st December.
As per a report by Topline Securities, “The governor stated that total external financing requirement for FY24 is US$24.6bn out of which US$2.8bn has already been paid. According to him SBP has received commitments for rollovers worth US$8bn, with an additional expectation of US$3bn to be rolled over. The net payable amount stands at US$8bn.”
This puts Pakistan in a precarious position, as another round of devaluation could have severe inflationary consequences.