Pakistan’s central bank faces a tough call on monetary policy

KARACHI: Pakistan's central bank faces a tough choice on whether to raise its key interest rate this month as inflation pressures ease but the IMF urges caution on loosening monetary policy.

Financial market participants are divided over whether the State Bank of Pakistan (SBP) will increase its benchmark interest rate on July 31 given that inflation is expected to soften further in the months ahead.

The International Monetary Fund (IMF), however, recommends keeping the monetary policy tight in order to lower inflation, re-anchor expectations, and encourage external sector rebalancing through the exchange rate.

Topline Research polled significant market participants about their forecasts for the policy rate and important macro estimates in order to get their opinion on the outlook for the next monetary policy. The participants were divided on the policy rate increase, Topline Research said.

“As per the survey, 48 percent of participant expects no change in policy rate while 46 percent of participants expect 100bps [basis points] increase in policy rate. Rest 6 percent expect policy rate to increase by more than 100bps,” it added.

During its scheduled meeting on June 12, the SBP kept the policy rate unchanged. However, in a surprising turn of events, the SBP convened an emergent meeting on June 26 in which it decided to increase the policy rate by 100bps to 22 percent. This decision was made in recognition of the need to establish a positive real interest rate and serve as an anchor for managing and moderating inflation expectations, SBP cited.

Pakistan’s CPI Inflation in June 2023 came down to 29.4 percent year-on-year from 38 percent in May attributed to the high base effect from the last year along with lower food prices.

“We anticipate monthly CPI inflation to soften further in upcoming months and gradually decline over the next 12 months because of base effect along with tight monetary and fiscal policy. Decline in petrol and diesel prices will also ease inflation in coming months, unless there is any major pressure on PKR and global oil prices,” said an analyst at Topline Securities.

“Considering above factors, we also expect no change in upcoming MPC meeting. However, even if there were a 100bps change, it would not have a major impact due to the high base,” he said.

Arif Habib Limited, another brokerage house expects the SBP to hold the policy rate at 22 percent at its upcoming meeting.

“Our working suggests that FY24’s headline inflation is likely to clock-in at around 20.8 percent, lower than IMF’s estimates of 25.9 percent,” it said.

“With these projections, notably, real interest rates have already turned positive on a forward-looking basis. However, considering the higher inflation forecasts presented by the IMF, some market participants now anticipate the possibility of further interest rate increase in the upcoming monetary policy meeting,” it added.

In the IMF Country Report, its staff emphasised that the SBP will need to continue its tightening cycle to re-anchor expectations given that inflationary pressures are expected to persist over the coming year, including because the impact of exchange rate corrections will continue to reverberate through the economy.

“Although the latest policy rate move from the SBP is a welcome step, the authorities have generally been sanguine about inflationary pressures quickly receding and returning to their 5–7 percent inflation target range by end-FY25,” it said.

“The SBP agreed to maintain a tight monetary policy stance—higher rates and prudent use of liquidity injections— as needed, given incoming data, to achieve real positive interest rates, on a forward looking basis, and place inflation and inflation expectations on a clear downward path,” the IMF report stated. At the same time, improving the monetary transmission and the monetary operation framework will be important, according to the report.