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Pakistan: Status quo in May MPS due to Covid uncertainty and fiscal contraction

  • The SBP maintained the policy rate at 7% in May MPS as guided in the previous meeting
  • Key reasons: core inflation remains modest, uncertain growth outlook amid Covid-19, and fiscal contraction
  • The SBP considers accommodative monetary policy as appropriate for the near term

Status quo in May MPS due to Covid-19 uncertainty and fiscal contraction

The State Bank of Pakistan (SBP) has maintained the policy rate at 7.0% (unchanged since June 2020). The decision is consistent with the SBP’s guidance in previous MPS (March 2021) and market consensus. The SBP also maintained that the accommodative monetary policy remains appropriate and any change will be gradual. Broadly, the reasons for keeping the policy rate unchanged were same as in the previous MPS – growth, though impressive, remains uncertain; outlook for fiscal consolidation ahead; and core inflation remains stable amid few visible demand pressures.

Reasons behind the status quo decision include:

  • The recent spike in inflation was due to the lingering impact of the power tariff hike in February 2021 and still-high food inflation. As per the SBP, about 75% of the increase in inflation was led by a narrow set of items from the CPI basket – which will not react to changes in monetary policy. The SBP also draws comfort from little change in wage demand despite high inflation. It is, however, awaiting the Budget announcement to firm up its outlook for inflation in FY22. 

  • The GDP growth is now expected to be 3.9% for FY21 (government estimates), compared with its projection of 3-3.5% until the previous MPS. This was led by a sharp rebound in commodity related sectors, which also propelled the Services sector. The SBP attributes the sharp monetary easing and fiscal stimulus measures since the onset of Covid-19 for the rebound in growth. Nonetheless, the outlook remains uncertain as the third wave of Covid-19 rages globally; and the SBP deems “the cost of withdrawing stimulus measures early” to be greater than that of being late.  

  • The SBP pointed out that Pakistan’s fiscal balance has improved since the onset of Covid-19 – with a primary balance of c.1% of GDP in FY21 so far – and the increase in debt to GDP since Covid-19 has been relatively modest compared with other regional countries. But the central bank expects fiscal contraction in the upcoming Budget – calling for the monetary policy to remain accommodative.

  • The external account remains the most encouraging among the economic indicators, thanks to very strong growth in remittances (up c.25% yoy in 10MFY21) and a near-flexible exchange rate regime. Remittances are expected to remain above US$2.0bn per month as the reasons for the recent uptick seem well-entrenched, as per the SBP.    

The SBP considers the present accommodative monetary policy to be appropriate and it will aim for positive real rates only gradually. Details of the upcoming Budget, the future path of Covid-19 in Pakistan, and global commodity price trends are key variables which will influence the next monetary policy decision in July 2021, in our view.


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