Pakistan raised its policy rate by 50 basis points to 10.00 percent, as expected, describing inflationary pressures as "resurging," with the result that the inflation rate is likely to remain between 10.5 percent and 11.5 percent and this could damage the productive capacity of the economy, encourage an outflow of capital and increase the pressure on the exchange rate.
It is the third change in rates by the State Bank of Pakistan (SBP) in 2013, for a net rise in rates of 50 basis points. SBP cut its rate by 50 basis points in June as it continued a two-year easing cycle that lowered the policy rate by 500 basis points. But in September the SBP reversed course, concluding that interest rates were not the cause of low credit demand, and raised its rate by 50 basis points to combat rising inflation.
Pakistan's inflation rate rose to 9.08 percent in October, the fifth month in a row with rising inflation after reaching a year-low of 5.13 percent in May, the culmination of 12 months of falling inflation.
Economists had expected the rise in inflation to lead to a rate rise by the SBP and some see further tightening in early 2014.
The SBP, which targeted inflation of 9.5 percent in 2012/13, said "resurging" inflationary pressures could be seen in the first four months of fiscal 2014, which began on July 1, and both food and non-foods were contributing to the rise.
"With the continuation of these trends CPI inflation is likely to remain at an elevated level, between 10.5 to 11.5 percent," the bank said.
The bank added that higher inflation could raise the incentives for borrowing and discourage savings, raising demand pressure through consumption and dampen investment and thus the productive capacity of the economy.
"In addition, with fragile external flows, a negative real return can encourage the outflow of foreign exchange, increasing the pressure on the exchange rate," the SBP said.
Pakistan's rupee started depreciating rapidly toward the end June, with the rupee trading around 107.5 to the U.S. dollar today, down 8.5 percent from 97.35 at the end of last year.
Pakistan's economy slowed slightly in the 2012/13 fiscal year with Gross Domestic Product expanding by 3.59 percent, down from 4.36 percent the previous year.
The SBP said the fundamentals of the economy appeared stable and was encouraged by a successful political transition following election, the resolution of energy related circular debt and further structural reforms that are underway.
"Although it is too early to conclude about their impact, there are some indications of a pickup in economic activity," the bank said, adding exports had picked up by 1.3 percent in the first quarter of the current fiscal year.
But weak financial inflows continued to lead to a deterioration in the external accounts with a current account deficit of US$1.2 billion in the July-September quarter, the same as in the previous quarter, and a wider trade deficit due to imports rising faster than exports.
Including substantial repayments to the International Monetary Fund (IMF), SBP's reserves declined by $1.3 billion in the first quarter to $4.2 billion as of Nov. 1.