Monday, May 20, 2019

Pakistan raises rate 150 bps after IMF deal, rupee rises

    Pakistan's central bank raised its policy rate for the third time this year and the 8th time since January last year, saying the rate hike was required to address underlying inflationary pressures from the recent rise in inflation, a sharp fall in the rupee's exchange rate, the elevated fiscal deficit and potential increases in utility tariffs.
    The State Bank of Pakistan (SBP) raised its policy rate by a higher-than-expected 150 basis points to 12.25 percent and has now raised it by 225 points this year following hikes in January and March.
    Since January 2018, when SBP began tightening its monetary policy, the rate has been raised by a total of 6.50 percentage points.
    The rate hike is the first under SBP's new governor, Reza Baqir, former International Monetary Fund economist, who was appointed on May 4, the day after former Governor Tariq Bajwa and the head of the tax collection body were removed from their posts.
    Last week the IMF and Pakistan reached a staff-level agreement for a 39-month extended fund facility of US$6.0 billion aimed at supporting major reforms to improve public finances, the energy sector and loss-making state-owned enterprises that drain public finances.
    The agreement also includes a market-determined exchange rate for the rupee, with IMF saying authorities are focused on reducing inflation and are committed to strengthening SBP's "operational independence and mandate."
   The rupee rose around 1 percent in response to the rate hike to 146.8 to the U.S. dollar, reversing some of last week's 4.8 percent plunge in its exchange rate. Since the start of this year the rupee has fallen 4.8 percent and since the start of 2018 it has lost 25 percent of its value.
     "SBP will continue to closely monitor the situation and stands ready to take measures, as needed, to address any unwarranted volatility in the foreign exchange market," SBP said, adding the current level of reserves are below the standard of three months of import cover.
     Pakistan's inflation rate has been boosted by an increase in domestic fuel prices, higher food prices and inputs costs that are likely to keep upward pressure on inflation "for some time," SBP said, adding surveys also show most households expect higher inflation over the next 6 months.
     Pakistan's consumer price inflation rate eased slightly to 8.8 percent in April from 9.4 percent in March and SBP forecast average inflation in fiscal 2019, which ends June 30, of 6.5 - 7.5 percent and "considerably higher" inflation in fiscal 2020.
     The fiscal deficit in fiscal 2019 is also likely to be considerable higher than last year due to a shortfall in revenue collection, higher-than-budgeted interest payments and securities expenditures, adding to inflationary pressures because a growing portion of this deficit has been financed through borrowing from the central bank.
     "A greater reliance on central bank financing of the widening fiscal deficit has diluted the impact of previous rate hikes," SBP said, "the resulting increase in monetization of the deficit has added to inflationary pressures."
     The government borrowed 45.8 trillion rupees from SBP from July 2018 through May 10, 2.4 times the borrowing during the same period in fiscal 2018, and a major portion of this (3.7 trillion rupees) reflect a shifty away from commercial banks that are reluctant to lend at prevailing rates.
    SBP expects the IMF agreement to unlock external financing and thus improve economic activity with growth down this year but then rising modestly in fiscal 2020, supported by a rebound in agriculture and government incentives for export industries.
    Pakistan's current account deficit narrowed 29 percent to US$9.6 billion from July to March from a deficit of $13.6 billion in the same period last year while reserves fell to $8.8 billion as of May 10 from $10.5 billion at the end of March.

     The State Bank of Pakistan released the following statement:

"Key developments since the last MPC statement
There have been three notable developments since the last Monetary Policy Committee (MPC) meeting in March 2019. First, the government of Pakistan has reached a staff-level agreement with the International Monetary Fund for 39-month long Extended Fund Facility of around US$ 6.0 billion. The program is designed to restore macroeconomic stability and support sustainable economic growth, and is expected to unlock considerable additional external financing. Second, trends in government borrowing reflect a widening fiscal deficit during the first nine months of FY19 when compared to the same period in FY18. In addition, a greater reliance on central bank financing of the deficit has acted to dilute the impact of previous monetary tightening. Finally, since the last MPC, the exchange rate has depreciated by 5.93 percent to PKR 149.65 per USD, at the close of 20th May 2019, reflecting a combination of underlying macroeconomic factors and market sentiment considerations.

Real sector
SBP’s estimates show that economic growth is expected to slow in FY19 but rise modestly in FY20. This slowdown is mostly due to lower growth in agriculture and industry. More than two-thirds of real GDP growth in FY19 is expected to come from services. Going forward, some gradual recovery in economic activity is expected on the back of improved market sentiment in the context of the IMF supported program, a rebound in the agriculture sector and government incentives for export- oriented industries.

External sector
The current account deficit narrowed to US$ 9.6 billion in Jul-Mar FY19 as compared to a deficit of US$ 13.6 billion during the same period last year, a fall of 29 percent. The reduction is mainly driven by import compression and a healthy growth in workers’ remittances. This impact was partially offset by higher international oil prices. The non-oil trade deficit declined from US$ 13.7 billion in Jul-Mar FY18 to US$ 11.0 billion in Jul-Mar FY19 reflecting the impact of stabilization policies implemented so far. Recent indicators suggest export volumes have begun to grow although total export receipts have not grown due unfavorable prices.
Despite the improvement in the current account and a noticeable increase in official bilateral inflows, the financing of the current account deficit remained challenging. Consequently, reserves declined to US$ 8.8 billion as of 10th May 2019 from US$ 10.5 billion at end-March 2019. The exchange rate also came under pressure in the last few days. In SBP’s view, the recent movement in the exchange rate reflects the continuing resolution of accumulated imbalances of the past and some role of supply and demand factors. SBP will continue to closely monitor the situation and stands ready to take measures, as needed, to address any unwarranted volatility in the foreign exchange market. Furthermore, the current level of reserves is below standard adequacy levels (equal to three months of imports cover). As noted in previous MPC statements, deep structural reforms are required to improve productivity and competitiveness of export-oriented sectors and improve the trade balance.

Fiscal sector
The overall fiscal deficit is likely to be considerably higher during Jul-Mar FY19 as compared to the same period last year due to a shortfall in revenue collection, higher than budgeted interest payments and security related expenditures. From a monetary policy perspective, a growing portion of the fiscal deficit has been financed through borrowings from SBP. In absolute terms, the government borrowed Rs 4.8 trillion from SBP during 1st Jul-10th May FY19, which is 2.4 times the borrowing during the same period last year. A major portion of this borrowing from the SBP (Rs 3.7 trillion) reflects a shift away from commercial banks which were reluctant to lend to the government at prevailing rates. The resulting increase in monetization of the deficit has added to inflationary pressures.

Monetary sector and inflation outlook
Despite the recent tightening of monetary policy, private sector credit rose 9.4 percent during 1st Jul-10th May, FY19. Much of the increase in credit was for working capital needs due to higher input prices. The expansionary impact of higher government borrowing and private sector credit on broad money supply (M2) was partly offset by a contraction in net foreign assets of the banking sector. In aggregate, broad money supply grew by 4.7 percent during 1st Jul – 10th May, FY19.
The consumer price index (CPI) rose 9.4 percent in March 2019 and 8.8 percent in April 2019, on a y-o-y basis. Average headline CPI inflation reached 7.0 percent in Jul-Apr FY19 compared to 3.8 percent in the same period last year. Moreover, the annualized headline month-on-month inflation has risen considerably in the last three months due to the recent hike in domestic fuel prices and rising food prices and input costs. As such, inflationary pressures are likely to continue for some time. The most recent IBA-SBP consumer confidence survey also shows that most households expect higher inflation during the next six months. Taking into account the recent developments discussed above and outlook for key sectors, average headline CPI inflation is expected to be in the range of 6.5-7.5 percent in FY19 and it is anticipated to be considerably higher in FY20. This inflation outlook is subject to a number of upside risks from an expected rationalization of taxes in the upcoming budget, potential adjustments in electricity and gas tariffs, and volatility in international oil prices. The inflation outlook suggests a fall in real interest rates on a forward- looking basis.

Policy rate decision
Taking into account the above considerations and the evolving macroeconomic situation, the MPC noted that further policy measures are required to address underlying inflationary pressures from (i) higher recent month-on-month headline and core inflation outturns; (ii) recent exchange rate depreciation; (iii) an elevated fiscal deficit and its increased monetization, and (iv) potential adjustments in utility tariffs. In this context, the MPC decided to increase the policy rate by 150 bps to 12.25 percent effective from 21st May 2019."


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