The State Bank of Pakistan (SBP) has raised the policy rate by 150bps to 8.75% – which follows the 25bps hike in September 2021. The key reason was that risks of high inflation and current account deficit have outpaced expectations, while growth outlook remains intact. The SBP decided on a large move – more than our expectation and market consensus of 100bps – as it aimed at reducing uncertainty in the markets (about future interest rates) and avoiding the need for a similarly large move in subsequent monetary policy meetings.
Reasons behind the increase in interest rates:
The SBP sees little risk to the 4-5% GDP growth outlook for FY22. LSM is expected to slow down (from 5.2% yoy in 1QFY22) because of the tightening measures and rising input costs, but multiyear strong growth in Agriculture (record yields expected for most major crops) will make up for the lag in LSM.
CPI has averaged 8.75% in 4MFY22, where the mom increase in CPI in Sep-Oct 2021 exceeded 2%. Higher commodity prices and domestic administered prices (of food and energy) pose risks to the SBP’s projected range of 7-9%. Even core inflation (although averaging c.7% during 4MFY22) has been creeping up of late; note that most indices within core inflation are posting 8-9% yoy rise (the overall index is dragged by Education and other Covid affected segments).
The other major driving factor behind the MPC decision is the large current account deficit of US$5.0bn in July-Oct 2021 (US$1.66bn in October) due to significantly higher imports of goods and services – led majorly by higher commodity prices (of energy and food imports). So far, the burden has fallen majorly on the exchange rate as the PKR has depreciated more than 9% FY22td. Above adjustments in the monetary policy and subsequently in the fiscal policy will play a greater role in moderating the external account imbalances.
Fiscal deficit clocked in at a moderate c.0.8% of GDP in 1QFY22 compared to c.1% same period last year, but the SBP hinted at fiscal tightening in the near future – in our view, this will mostly entail withdrawal of tax exemptions (still in place on certain essential food and healthcare items), mandated by the IMF as a pre-condition for program resumption.
For future, the SBP guided that the end-goal of moderately positive real interest rates remains well intact but stopped short of giving a revised inflation outlook. We think there is a high probability that inflation will average above 10% in the next 12 months; and as such, the SBP would aim for double-digit policy rate by March-April 2022 from 8.75% presently. Future increases will however be smaller than the 150bps in today’s MPS, unless conditions worsen. As for the markets, money market rates had already touched 9% before the MPS; and, beyond a knee-jerk initial reaction, the equity markets should not decline significantly as stock prices have already incorporated the monetary tightening (which is only brought forward in today’s MPS). Refer to our sector-wise impact on the following page.