The State Bank of Pakistan (SBP) raised its benchmark policy rate by 125 basis points to 15% from 13.75% on Thursday.
The most recent increase in the key policy rate by the central bank is more than what the market thought it would be.
The SBP has raised the policy rate by 8% since September 2021.
Since the last meeting, the Monetary Policy Committee (MPC) has noticed three positive changes, such as the end of subsidies for energy that couldn’t be kept up in the long run and the passing of the budget for fiscal year 2023.
“This has prepared the path for completion of the ongoing IMF programme assessment,” the central bank said. “This will make sure that tail risks related to Pakistan’s need for outside funding are avoided.”
A $2.3 billion commercial loan from China helped support foreign exchange reserves, which had been decreasing since January due to current account constraints, external debt repayments, and a lack of fresh international inflows.
Third, economic activity continues to be robust, with near 6% growth continuing until fiscal year 2023, the SBP said.
Pakistan has a smaller growth-inflation trade-off than many countries with a worse post-COVID recovery.
Several negative events eclipsed the good news. Most countries have multi-decade high inflation, and central banks are responding aggressively, depreciating emerging market currencies.
This substantial monetary tightening happened despite concerns about a downturn in the global economy and recession prospects, the SPB stated.
Since energy subsidies were taken away, headline and core inflation both reached their highest levels in 14 years in June.
The current account deficit unexpectedly jumped in May, while the trade deficit continued its post-March expanding trend to hit a 7-month high in June.
The currency reserves and rupee remained under pressure, increasing inflation expectations.
The MPC emphasised strong, timely, and credible policy efforts to curb domestic demand, minimise inflationary pressures, and reduce external stability threats.
Pakistan is going to lose a lot of money because of rising prices, tax hikes, and price increases for utilities.
Without macroeconomic adjustments, price stability, financial stability, and growth are in danger.
This could cause inflation to get out of control, currency reserves to run out, and tightening steps to be taken quickly and forcefully, stopping economic activity and jobs.
In the sake of social stability, this adjustment must be handled equally across the population by ensuring that the relatively well-off absorb most of the increase in utility prices and taxes while the more vulnerable receive well-targeted and adequate aid.
According to the MPC’s baseline view, headline inflation is expected to stay high for most of the fiscal year 2023 before dropping sharply to the target range of 5% to 7% by the end of the fiscal year 2024. This will be caused by tighter measures, normalisation of global commodity prices, and positive base effects.
In the past three months, a needless increase in government spending has stopped the needed drop in economic activity that was going to happen through fiscal year 2022 as a result of tightening money.
In fiscal year 2023, growth is likely to decline by 3% to 4% as monetary tightening and fiscal consolidation close the positive output gap and reduce demand-side inflation pressures.
In May, the current account deficit grew to $1.4 billion because Eid cut back on exports and money sent home.
June’s trade imbalance was $4.8 billion, $1.7 billion greater than in February. In the last three months, non-energy imports have moderated due to government and SBP efforts.
This drop was countered by energy imports, which grew from $1.4 billion in February to $3.7 billion in June.
Without quick steps to cut energy imports, like early market closings, less electricity use in homes and businesses, and more work-from-home and carpooling, it could be hard to control the trade deficit.
The current account deficit is forecast to fall to roughly 3% of GDP as imports drop with cooling growth and exports and remittances remain resilient.
Inflation jumped from 13.8% in May to 21.3% in June, the most since 2008.
Energy, food, and core inflation all rose sharply, and over 80% of the CPI basket saw inflation above 6%.
Strong domestic demand and supply shocks drove core inflation up to 11.5% in urban regions and 13.5% in rural areas.
Even though fiscal and monetary policy is getting tighter, demand-pull inflation is expected to stay high for most of the fiscal year 2023 because fuel and electricity subsidies are being taken away.
Inflation in 2023 is expected to be over 20% before falling dramatically in 2024. This baseline estimate is very uncertain because commodity prices, government spending, and the exchange rate can all make a big difference.
The MPC will keep an eye on inflation, the stability of the economy, and growth prospects and act as needed.