ISLAMABAD – The Monetary Policy Committee (MPC) of the State Bank of Pakistan has decided to keep the policy rate at 7 percent for the next two months. The MPC was encouraged by the upward revision of growth forecast for fiscal 21 to 3.94 percent. He noted that this confirms the strength of the widespread economic rebound underway since the start of the fiscal year, thanks to targeted fiscal measures and an aggressive monetary stimulus. This positive momentum is expected to persist, translating into stronger growth next year.
The MPC has warned that inflation is likely to remain high in the coming months due to the recent hike in electricity tariffs, pushing the average for FY21 near the upper end of the announced 7-9% range.
As supply shocks subsequently dissipate, inflation is expected to gradually move closer to the target range of 5-7% over the medium term.
He noted that inflation climbed to 11.1 percent in April, mainly due to rising electricity tariffs as well as a month-over-month recovery in food prices, in part due to the usual seasonality around Ramazan.
The MPC noted that food and energy supply shocks still dominate, with a small number of energy and food products in the CPI basket accounting for about three-quarters of the rise in inflation since January.
The MPC also observed that, although core inflation in urban areas increased by around 1.5 percentage points during this period, available data suggests that demand pressures on inflation continue to be relatively contained.
This reflects the fact that despite the economic recovery, there is still spare capacity after last year’s contraction.
The second-round effects of supply shocks are not visibly apparent either: the pressures on prices are concentrated in a few items, wage growth is moderate while keeping a ceiling on costs and inflation expectations remain reasonable. anchored.
The latest national income accounts data confirms that the economy has rebounded strongly from last year’s severe Covid shock, led by services and industry.
The industrial sector is estimated to have grown 3.6% in FY21, driven by large-scale construction and manufacturing, particularly the food, cement, textile sectors. and automotive.
The strong rebound is also reflected in exceptionally strong growth recorded in several high frequency indicators over the three quarters of the year, including sales of fast moving consumer goods and POL products.
The agricultural sector is estimated to have increased by 2.8 percent, with production of three important crops, wheat, rice and maize, reaching record levels and that of sugarcane to its second highest level on record. achieved. Supported by strong performance in the commodity-producing sectors, services are believed to have rebounded from last year’s contraction to post growth of 4.4%, led by wholesale and retail trade.
The MPC noted that the current economic recovery has been supported by proactive and well calibrated policies of the government and the SBP since the covid shock.
Given the high level of public debt, targeted budget support has mainly been provided through a reallocation of spending focused on the most vulnerable, notably through the Ehsaas program.
This was made possible by the buffers that had been formed during the economic stabilization phase before the Covid pandemic, in particular the primary surplus achieved during the first nine months of fiscal year 20.
As a result, the fiscal year 20 budget deficit was contained and Pakistan experienced one of the smallest increases in public debt in the world after the covid shock, supporting market sentiment and investment prospects.
On the monetary side, an aggressive stimulus to 5% of FY20 GDP was provided by one of the largest interest rate cuts in the world, time-bound liquidity relief for creditworthy borrowers in the form of deferral of principal and restructuring of loans, as well as temporary refinancing and facilities to avoid layoffs (Rozgar program), support health facilities and promote investments (TERF).
The MPC noted that, unlike several previous upsurges of growth in Pakistan, the current economic recovery has been achieved without compromising external stability.
At $ 0.8 billion, the current account remained in surplus in the first 10 months of FY21 for the first time in 17 years.
In recent months, imports have resumed with the economic recovery, rising international commodity prices, as well as one-off shipments of wheat and sugar to alleviate temporary domestic shortages.
However, this is more than offset by record remittances, which reached all-time highs in April on a monthly ($ 2.8 million) and cumulative ($ 24.2 billion) basis.
In addition, exports have increased by almost 14 percent (y / y) so far this year. In March, Pakistan successfully completed the 2nd and 5th Combined IMF Program Reviews and returned to international capital markets raising $ 2.5 billion through an oversubscribed Eurobond, issued at returns below the initial price target.
Together, these positive external developments have kept the PKR broadly stable since the last MPC meeting around its pre-Covid level, and have seen SBP’s foreign exchange reserves rise to nearly $ 16 billion, a high in four years.
Going forward, the current account deficit is expected to remain small, modulated by the flexible exchange rate regime, and external financing needs should be satisfied comfortably, further strengthening the currency buffers.
As forecast in this year’s budget, fiscal consolidation has progressed well in the first three quarters of FY21. At 3.5 percent of GDP, the budget deficit is 0.6 percentage point below. last year, despite an increase in interest payments and covid spending. Spurred on by a rebound in sales tax and direct taxes, the collection of the FBR tax (net of refunds) increased by 14%. Restrictions on additional subsidies and austerity measures limited current spending other than interest, which rose 6.7 percent, about half the rate last year.
As a result, the primary balance recorded a surplus of 1 percent of GDP, its highest level in the first three quarters in 12 years.
Cumulatively through April, the flow of credit to the private sector increased by 43% (year-on-year), led by fixed investments and consumer loans, mainly due to the low interest rate environment and SBP refinancing plans, in particular TERF and LTFF.
Looking ahead, absent unforeseen circumstances, the MPC expects monetary policy to remain accommodative in the near term and any policy rate adjustment to be measured and gradual to achieve slightly positive real interest rates. over time. If demand side pressures emerge as the recovery becomes more sustainable and the economy returns to full capacity, the MPC noted that it would be prudent for monetary policy to begin to normalize with a gradual reduction in the degree. of accommodation.
This would help ensure that inflation does not take root at a high level and that financial conditions remain orderly, thus supporting sustainable growth. In making its decision, the MPC took into account the main trends and prospects in the real, external and fiscal sectors and the resulting outlook for monetary conditions and inflation.