Ahmed Mukhtar Naqshbandi
The State Bank of Pakistan (SBP’s) FX reserves are declining due to scheduled repayments, while expected inflows have not materialized as planned due to uncertainty, both internationally and domestically, says a SBP official.
In a current episode of the State Bank of Pakistan (SBP) Podcast, Director Monetary Policy Department, SBP, Mr. Fida Hussain, talks about the rationale and key reasons behind the latest monetary policy decision.
State Bank of Pakistan recently announced its Monetary Policy decision, raising the policy rate by 100 basis points, taking it to 17%. The monetary policy decision has implications for businesses and consumers and therefore is very important for all stakeholders.
There are three important factors, which the monetary policy committee (MPC) has mentioned in its statement. The first factor is elevated level of inflation, which slight decreased from 26.6% in October to 23.8% in November and stood at 24.5% in December 2022.
CPI Inflation
Not only headline inflation but core inflation has also been on a rising trend for the last 10 months, indicating the presence of some demand-side pressures as well as second-round impact of earlier energy and food price increases.
Furthermore, inflation expectations, among both businesses and consumers, have drifted upwards. The monetary policy noted that if the central bank did not act in the current situation, these expectations may contribute to further rise in inflation going forward.
State Bank of Pakistan believes, that the second important factor in the monetary policy decision is that the near-term challenges to Pakistan’s external sector and its outlook have increased, despite the sizable reduction in the current account deficit.
Forex Reserves
The State Bank of Pakistan (SBP’s) FX reserves are declining due to scheduled repayments, while expected inflows have not materialized as planned due to uncertainty, both internationally and domestically.
The third important factor is the uncertain global economic conditions. Currently, the global economy is undergoing a slowdown and there are indications that some major advanced economies may experience recession.
This global environment poses downside risks to the outlook for exports and remittances and at the same time may benefit inters of lower commodity prices and ease in global financial conditions.
International Recession
For instance, a slower pace of increase in interest rates by advanced economy central banks may help revive capital flows to emerging and developing economies and make it easier for them to tap international capital markets.
Going forward, State Bank of Pakistan (SBP) expects to benefit from slightly declining commodity prices and if this trend continues, it would have a positive impact on our imports and the current account balance.
With regard to food inflation, the State Bank of Pakistan (SBP) Director highlighted that during the winter months of November and December, the shelf lives of food products tend to increase, leading to improved supplies and therefore lower prices.
Food Prices
However, this was not the case in 2022, as food prices have risen sharply; this indicates the need for active price monitoring at the local level, and administrative measures to ensure smooth and continuous supplies.
The higher food inflation and core inflation, if allowed to entrench, create the risk of a wage-price spiral, and therefore necessitated a tight monetary policy response.
Concerning the impact of rising interest rates on economic activity, it is pertinent to mention here that the State Bank of Pakistan’s primary mandate is ensuring price stability.
High inflation makes it very challenging for consumers and businesses to plan their savings and make investment decisions, which would affect growth prospects.
Monetary Policy To Squeeze Growth in Short Term
In this context, the State Bank of Pakistan (SBP) recognizes the short-term costs of monetary tightening for economic activity, but also believes that curbing inflation now is essential for ensuring sustainable growth over the medium to long term.
The podcast also highlighted the need for fiscal policy to work in tandem with monetary policy to curtail demand-side pressures when inflation is high.
Expansionary fiscal policy dilutes the impact of monetary tightening. Therefore, adhering to planned fiscal consolidation under the current circumstance would support the SBP’s efforts to curb high inflation.
The potential inflationary impact of fiscal and exchange rate adjustments was also reviewed by the monetary policy committee (MPC). The MPC analyzed different scenarios envisaging the impact of various likely adjustments, on which the information was available at the time of the meeting.
