Pakistan’s central bank is expected to jack up the benchmark policy rate in the range of 100 to 200 basis points (bps) at its meeting on Tuesday in a bid to meet a key condition of the International Monetary Fund’s (IMF) loan programme.
The policy rate is already at a record high of 20%. The State Bank of Pakistan (SBP) argues that a high rate increases the cost of borrowing, which helps to control demand for bank financing from businesses and households and reduce consumer demand for goods. Consequently, it reins in inflation and ensures sustainable economic growth. Analysts pointed out that inflation had hit a six-decade high at 35.4% in March 2023 and projected that it would peak out somewhere in the range of 37-40% over the next two months.
A section of analysts, however, argue the persistent rate hikes have lately become ineffective in controlling inflation, as the demand for bank credit has gone dead. Rather, the rate increase will dent economic activities.
The central bank has increased the policy rate cumulatively by 13 percentage points in the past 18 months.
Ismail Iqbal Securities Head of Research Fahad Rauf, while quoting media reports, pointed out that the IMF had demanded an aggressive increase of five to six percentage points in policy rate in February.
The central bank, however, was not in favour of such a staggering increase in one go. Following that approach, the central bank increased the policy rate by three percentage points to 20% by March.
“It is now expected to further raise the rate by two percentage points in line with the IMF’s recommendation,” Rauf said.
“The policy rate has become ineffective since surpassing the 15% mark (in November 2022) as demand for bank credit has dried up since then,” he said.
“Later, further hikes have badly impacted economic growth, which is likely to contract slightly in the current fiscal year compared to 6% expansion last year (FY22).”
Rauf was of the view that inflation had become a big challenge, which spiked after the government let the rupee depreciate significantly, increased energy prices and raised tax rates on the IMF’s recommendation.
He expected inflation to reach its peak in the range of 38-40% over the next two months.
Pak-Kuwait Investment Company Head of Research Samiullah Tariq said that the SBP would increase the policy rate by two percentage points to control the runaway inflation.
Rate hikes had helped restrain inflation, he said, adding had the central bank not increased the policy rate, inflation would have been higher than the prevailing levels.
Tariq estimated that inflation would peak in the range of 37-39% in April and May and after that it would start decelerating gradually.
The SBP has recently revised up its projection for average inflation to 27-29% for the current fiscal year.
Arif Habib Limited (AHL) Head of Research Tahir Abbas, in a commentary, said that the SBP would increase the key policy rate by one percentage point.
“Inflation is likely to remain elevated in the coming months as the impact of external and fiscal adjustments (including additional taxation, tariff hike, weakening currency and Ramazan factor) is felt,” he said.
“Besides…the decision to raise the policy rate will also facilitate the long-awaited ninth review of the IMF, which is crucial for Pakistan as it will pave the way for a loan tranche of $1.2 billion and unlock inflows from other international creditors.”
Topline Research, in its note, stated that it expected a one to two-percentage-point increase in policy rate in the upcoming Monetary Policy Committee (MPC) meeting considering the higher-than-expected inflation and rupee devaluation against the US dollar.
“We see the Consumer Price Index (CPI)-based inflation to average around 28% in FY23 (compared to around 11% last year).”
Published in The Express Tribune, April 4th, 2023.
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