Moderation in demand growth: SBP holds policy rate with inflation, CAD seen easing

KARACHI: The State Bank of Pakistan (SBP) kept its benchmark interest rate unchanged on Monday, as expected, and signalled rates would not change anytime soon because of easing inflationary pressures and improvement in external current account amid fiscal tightening.

“At today’s meeting, the Monetary Policy Committee (MPC) has decided to maintain the policy rate at 9.75 percent. Last time, the Monetary Policy Committee in December raised the policy rate by 100 basis points and in its forward guidance it had clearly said the rates would not need to rise in the near-term,” SBP Governor Dr Reza Baqir told in-person at a virtual news conference, unveiling the latest policy decision and releasing economic projections.

“We don’t see a case for a tighter monetary policy because of the fiscal consolidation after the enactment of the supplementary finance bill,” he added. The SBP sees moderation in the demand growth and the economic growth remains sustainable.

Inflation is expected to stay high in the near-term due to base effect and we could see more increase in January, compared with the previous month, but medium-term inflation outlook has improved, he said.

“The current account deficit is stabilising and after being stabilised we expect it will slow down gradually. We may see some improvement going forward. However, our projection for the current account deficit in FY2022 remains intact at $14 billion or 4 percent of GDP, but we see our non-oil deficit to be in surplus,” the SBP governor added.

The central bank struck a sanguine tone, confident the actions the government and it had taken so far were working. In the last policy, the MPC had considered the measures taken to lower inflation and keep the ongoing economic recovery sustainable.

These measures included a cumulative 275 basis point increase in the policy rate, higher bank cash reserve requirements, regulatory tightening of consumer finance, and curtailment of non-essential imports, said the latest policy statement.

The SBP said since the last meeting, some developments show signs of falling inflation supported by demand-moderating measures. "Recent economic growth indicators are appropriately moderating to a more sustainable pace. While year-on-year headline inflation is high and will likely remain so in the near-term due to base effects and energy prices, the momentum in inflation has slowed with month-on-month inflation flat in December compared to a significant rise of 3 percent in November," said the statement.

Inflation expectations of businesses have also declined considerably. The current account deficit appears to have stopped growing since November and the non-oil current account balance is expected to achieve a small surplus for FY2022, it added.

Finally, and importantly, the enactment of the recent Finance (Supplementary) Act, 2022 represents significant additional fiscal consolidation compared to the budget and has lowered the outlook for inflation in FY2023.

Pushing back on market bets for a rate rise as soon as March, the SBP said the policy rate was very likely to remain unchanged.

“Looking ahead, and against the backdrop of these developments that have improved the inflation outlook, the MPC was of the view that current real interest rates on a forward-looking basis are appropriate to guide inflation to the medium-term range of 5-7 percent, support growth, and maintain external stability. If future data out turns require a fine-tuning of monetary policy settings, the MPC expected that any change would be relatively modest.”

The SBP has its FY2022 inflation forecast of 9-11 percent intact. “Together with low base effects, one-off cost-push pressures from energy tariff increases and the removal of tax exemptions in the Finance (Supplementary) Act are likely to keep year-on-year inflation elevated over the next few months, close to the upper end of the average inflation forecast of 9-11 percent in FY22.”

However, during FY2023, inflation would likely decline toward the medium-term target range of 5-7 percent more quickly than previously forecast as demand-side pressures wane faster.

“Overall, growth in FY2022 is expected around the middle of the forecast range of 4-5 percent, slightly lower than previous expectations in light of moderating demand indicators and higher base effects from the upward revision in last year’s growth rate,” the statement said.

Risks to the outlook include, on the domestic front, the current growing Omicron wave and, on the external front, the possibility of faster than anticipated tightening by the US Federal Reserve and geopolitical events in Europe that might have implications for global financial conditions, according to the statement.

Looking ahead, the current account deficit was expected to decline through the remainder of FY2022, as import growth slows in response to a normalisation of global commodity prices and the fuller impact of demand-moderating measures.

Indeed, the non-oil current account deficit was less than one-fourth the record levels reached during the first half of FY18. The current account projection was subject to risks on both sides. On the one hand, the deficit could be larger if global commodity prices take longer to normalise. Or, it could be smaller if the fiscal consolidation has a faster and more pronounced impact on demand.