The decision about the monetary policy flashed amidst the announcement was against the majority of the investors and market drivers where the State Bank of Pakistan kept the interest rate unchanged for the second consecutive time in the hope that the inflation would be tamed in the coming months after keeping a check on the imports pattern.
The main thesis explained in the statement circled around the recent crack-down against dollar holders, which led to the selling of greenbacks on a large scale, helping the domestic currency to recover sharply. but sane observers believed that to control and sustain the current rupee recovery, the government needs to focus on the key indicators-exports, foreign direct investment and remittances.
These three factors can turn the tide improve inflows of dollars and help resolve the fear factor of the government on account of the scarcity of greenbacks to pay off debt liabilities. Better flows could help bridge the current account deficit, which for the last three months showed surplus signs, but in July, it recorded a deficit of $775 million and in August stood at around $160 million. In the two months of the current fiscal year, the current account deficit has been tamed a bit to $995 million as compared with $2.035 billion in the same period last fiscal year.
This allows the State Bank to keep interest unchanged where the authority has been too optimistic about inflation numbers in the coming months, analysts said.
The Bank’s Monetary Policy Committee noted some key developments since its July meeting. First, agriculture outlook has been improved based on the latest data on cotton arrivals, better input conditions, and satellite data indicating healthy vegetation of other crops. According to the Pakistan Cotton Ginners Association’s latest numbers, cotton arrivals till August 31, 2023, amounted to 3.041 million bales as against 1.539 million bales output in the same period corresponding year.
The central bank said that global oil prices have been rising and are now hovering over $90/barrel level.
Recent Disciplinary Measures in the Money Market
Finally, recent administrative and regulatory measures aimed at improving the availability of essential food commodities and curbing illegal activities in the foreign exchange market have begun to yield results. This has helped in narrowing the gap between the interbank and open market exchange rates. The Monetary Committee noted that it will continue to monitor the risks to the inflation outlook and, if required, it will take appropriate action to achieve the objective of price stability. At the same time, the Committee also stressed on maintaining a prudent fiscal stance to keep aggregate demand in check. This is necessary to bring inflation down on a sustainable basis and to achieve the medium-term target of 5 – 7 percent by end-FY25.
Before the start of this month when questioned by more than one and a half dozen analysts some 60 percent believed that interest rate would go up by 1.5 to 2 percent, 30 percent was of the opinion that it would be up to 1 percent and 10 percent estimated to 3 percent. Even the equity market has incorporated a change of benchmark interest rate to 1 to 1.5 percent and was discounted in the share prices. But some vested interest deliberately infused the news that an emergency meeting has been scheduled and interest rate might see a jump of 2 to 3 percent. This development was enough to give a big jolt to market and index descended by 1000 points in one of the sessions.
Panic buttons triggered selling pressure at the stock market and even yields on government securities crawled up at the money market.
The State Bank came out with clarification that there has been no such plan to hold an emergent meeting and Monetary Policy Committee meeting would be held as per schedule (Sept.14). But investors kept themselves on the sidelines, which resulted in lower volumes and few hand-picked companies led throughout the fortnight. But again, the treasury bills auction held on September 6 cemented the stance that interest rates would see a steep rise.
The three months cut-off yield rose by 162 basis points to 24.49 percent, and 12 months cut-off yields went up by 213 basis points to 25.07 percent, which was over the key interest rate of State Bank of 22 percent, which has been at a record high so far.
“Rupee Recovery”
The decision to launch a crackdown against commodities hoarders, dollar traders and those running gray markets where several outlets were raided changed the tides. On September 4 dollars in the open market and on September 5 at the interbank touched the historic high of Rs 333 and Rs 307.10 respectively. But after the launch of a crackdown where several exchange outlets were involved in the hundi/hawala work and running parallel markets were forced to close down where authorities arrested several dealers involved in selling foreign currency illegally.
Rupee, since its high at the open market, has recovered by Rs 34 and at the interbank dollar loose strength by Rs 10.10.
Moreover, to make the exchange companies more stringent, the State Bank also came out with a plan to trim out the small exchange companies asking the outlets to raise capital to Rs 500 million from Rs 200 million and also close small outlets or merge with the bigger ones. Moreover, it was also decided to give permission to leading banks to open their own exchange companies to make the dollar trade more transparent.
Smuggling Checks
The crackdown and check down on smuggling to Afghanistan forced the greenbacks to move down. The clippings of dollars forced several thousands of investors to offload their holdings. According to exchange companies in the last two weeks they have sold 60 to 75 million dollars to banks, which was merely two to three million dollars a month.
This recovery probably gave room to the State Bank to keep the interest rate unchanged. Though the impact has been much lesser as the country’s economy has already been in shambles and industrial activity has been in the red zone, and exports are falling thanks to stubborn inflation.
Inflation Anticipation & Interest Outlook
Iffat Mankani, CEO JS investments said that the decision made by the Monetary Policy Committee (MPC) to maintain the policy rate is primarily rooted in the anticipation of a stable inflation and currency situation.
Fiscal consolidation is also expected to support monetary policy in bringing inflation down to the medium-term target. Additionally, the MPC draws confidence from recent developments. Firstly, there has been a notable upswing in agricultural production, which holds promise for broader economic improvement. Secondly, regulatory actions have been initiated to curtail speculative activities in foreign exchange and commodity markets.
“These regulatory measures are seen as pivotal in averting excessive and erratic price fluctuations. The convergence of these factors is anticipated to foster price stability and, consequently, to invigorate economic growth”, Iffat said. Going forward, monetary policy will remain tightly linked with the external account; the weight of any forex burden from delays in external inflows will have to be carried squarely on the MPC’s shoulders, she said.
Ali Nawaz CEO Chase Securities said that the MPC noted that inflation is likely to increase significantly in September, mainly due to the base effect and the adjustment in energy prices.
It is expected that inflation will subsequently decline in October and maintain its downward trajectory from thereon. Overall, the MPC expects inflation to decrease in the second half of the year despite potential short-term increases.
“They stress the importance of fiscal consolidation, supply-side reforms, and a tight monetary policy to achieve price stability and sustainable economic growth”, Ali said. Considering the inflation and stable currency outlook provided by SBP, barring any unforeseen external shocks, it’s reasonable to characterize the current interest rate of 22% as the peak rate. “We can anticipate a reduction in interest rates during the fourth quarter of FY24 as inflation reduces”, he said.
Yousuf Saeed, head of research at Darson Securities, the State Bank kept the policy rate unchanged based on declining inflation going forward, as it already witnessed in July and August numbers.
Second half inflation is expected to decline drastically owing to base effect and if we look at the next 12 months’ average inflation, we are at a positive real interest rate.
“Equity market would take this expectation as positive because the consensus is opposite to what the decision announced at the September 14 meeting. Further, it also boosts industry confidence”, Yousuf said. The interest rate base effect will play an important part from Feb-Mar 2024 to help take the inflation to a declining trend, however, energy prices (Oil, Gas and electricity) play an important role and must keep an eye on it, he said.
