Economy improved, inflation feared: State Bank

KARACHI: The State Bank of Pakistan (SBP) Friday left the policy rate unchanged at 7 percent to act appropriately, as there are upside risks to current growth projection although inflation expectations remain well-anchored.

“Since the last meeting in November the domestic recovery has gained some further traction… there are upside risks to the current growth projection of slightly above 2 percent in FY21,” the SBP said in a statement.

“On the inflation front, recent out-turns are also encouraging, suggesting a waning of supply-side price pressures from food and still-benign core inflation.” The SBP expects inflation to fall within the previously announced range of 7-9 percent for FY21.

“The existing accommodative stance of monetary policy remained appropriate to support the nascent recovery while keeping inflation expectations well-anchored and maintaining financial stability,” it said.

Addressing a press conference after the Monetary Policy Committee's (MPC) meeting, Governor State bank Reza Baqir said the inflationary pressure was due to increase in utility prices and spike in international oil prices.

“But this phenomenon is temporary,” Baqir told a news conference. “Any change in the policy in future will be gradual,” he said. He dispelled the impressions that the policy stance was a prologue to restoration of International Monetary Fund’s programme.

“There are misconceptions among businessmen and markets that going to the IMF program means sudden reversal in the monetary policy stance,” he said.

“Now the current account is in surplus due to implementation of the market-based exchange rate regime. The increase in the central bank’s foreign exchange reserves to $13 billion from $7 billion is not because of foreign loans.”

For the first time, the SBP provided forward guidance, as it expected inflation to trend toward the 5-7 percent target range over the medium-term. “The forward guidance tool will help give us confidence, avoid surprises, ensure economic stability and ease uncertainty in the markets and the business community in future,” said Baqir.

The monetary stance is in line with the market expectations after the SBP delivered a cumulative reduction of 625 basis points five times during the last year to buoy sinking growth amid coronavirus lockdown. The economy contracted 0.4 percent during the last fiscal year of 2019/20.

The State Bank sees ‘considerable uncertainty’ around the outlook due to COVID-19. "In the absence of unforeseen developments, the MPC [Monetary Policy Committee] expects monetary policy settings to remain unchanged in the near term,” said the SBP.

“As the recovery becomes more durable and the economy returns to full capacity, the MPC expects any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates.”

The SBP said the economic recovery underway since July has strengthened in recent months. Large-scale manufacturing (LSM) grew 7.4 percent year-on-year in October and 14.5 percent in November. The manufacturing recovery is also becoming more broad-based, with 12 out of 15 subsectors registering positive growth in November and employment beginning to recover. So far this fiscal year, LSM has grown by 7.4 percent against a contraction of 5.3 percent during the same period last year.

The SBP said the trade deficit rose due to a rise in imports of machinery and industrial raw material, in line with the pick-up in economic activity, while remittances and exports continued to grow steadily. The current account remained in surplus during the first half of FY21, at $1.1 billion compared to a deficit of over $2 billion during the same period last year, mainly driven by workers’ remittances.

The current account deficit for FY21 is projected to remain below 1 percent of GDP. The SBP said fiscal developments have been largely in line with this year’s budget and the government has continued to adhere to its commitment of no fresh borrowing from the SBP.

The SBP said financial conditions remain appropriately accommodative at this early stage of the recovery, with the real policy rate in slightly negative territory on a forward-looking basis.

“As demand recovers and inventories fall in some sectors, working capital loans have also picked up for the first time since the onset of the COVID pandemic, although their level remains lower than last year,” said the SBP.

"The economy is improving and Pakistan's monetary policy supports it. The improvement is still not the kind that we would like to see for our nation," he added. He noted that the production capacity was not being fully utilised and that inflation was expected to rise as electricity prices increase.

"Our situation is better today. It's not what it was at the time of the IMF programme or in June 2019," Baqir underlined. The SBP governor mentioned that the Pakistani rupee strengthened when the US dollar was linked to the market rate. The exchange rate system was adapted to the market to improve the current account, he added, noting that the change was made in May-June 2019.

"We were asked if the dollar would skyrocket if left open [free as per the market system] but the Pakistani currency strengthened against it. Moreover, making it market-based strengthened our currency than other countries during the COVID-19 pandemic. During the pandemic, the Pakistani rupee fell 3.8% as opposed to those of other developing countries. Brazil's currency fell 21%," he explained.

"Further changes in the interest rate will be introduced in stages," Dr Baqir said.

The following are the key points of the MPC's statement.

· "Domestic recovery has gained some further traction"

· "Utility tariff increases may cause an uptick in inflation [but] this is likely to be transient"

· Inflation expected to "trend toward the 5-7 percent target range over the medium-term"

· With regard to the COVID-19 pandemic, external shocks such as the "still-elevated global cases, emergence of new strains, and lingering uncertainties about the roll-out of vaccines" around the world "could slow the recovery"

· "Large-scale manufacturing (LSM) grew by 7.4 percent (y/y) in October and 14.5 percent (y/y) in November" [but] "the level of manufacturing activity generally remained below average levels in FY19, pointing to continued spare capacity in the economy"

· "Cotton output is likely to decline more than expected based on latest production estimates [but] likely to be offset by improved growth in other major crops and higher wheat production"

· "While social distancing is still affecting some service sectors, wholesale, retail trade and transportation are expected to benefit from improvements in construction and manufacturing activity"

· "Following five consecutive months of surpluses, the current account registered a deficit of $662 million in December" and "trade deficit rose due to a rise in imports of machinery and industrial raw material"

· "Exports have also recovered to their pre-COVID monthly level of around $2 billion since September"

· "SBP’s foreign exchange reserves have risen to $13 billion, their highest level since December 2017"

· "Provisional estimates suggest that net FBR revenue grew by 3.0 and 8.3 percent (y/y) in November and December, respectively"

· "Working capital loans have also picked up for the first time since the onset of the COVID-19 pandemic, although their level remains lower than last year"

· "The prices of perishables, wheat, pulses and rice have declined [due] to conducive weather and various measures taken by the government to address supply-side issues".

Meanwhile, in December last year, the average retail prices for wheat and wheat flour decreased by 2.8% and 0.5%, respectively, along with an increase in the price of rice Irri-6 by 0.4%. There was no change in the price of rice Basmati when compared to the previous month’s prices.

Headline inflation based on the Consumer Price Index (CPI) decreased in December 2020 by 0.68% over November 2020 and increased by 7.97% over December 2019.

The prices of staple cereals and non-cereal food commodities in December 2020 experienced negligible to slight fluctuations, except for eggs which experienced a significant price increase and sugar which experienced a significant price decrease, when compared to the previous month’s prices.

In December 2020, the average ToT negligibly increased by 0.5% from the previous month.

In January 2021, the total global wheat production for 2020/21 is projected at 772.64 million MT, indicating a decrease of 1.02 million MT compared to the projection made in December 2020.