Monetary policy: Policy rate hike in line with expectations

State Bank increases policy rate by 50 basis point keeping inflation in mind.

KARACHI:

In line with analysts’ expectations, the State Bank of Pakistan (SBP) on Wednesday increased the monetary policy rate by 50 basis points with effect from November 18.

The discount rate, which will remain 10% for the next two months at least, is the interest rate at which commercial banks borrow from the central bank’s discount window.

Keeping rising inflation in mind, which was recorded at 9.1% in October, a majority of the analysts polled by The Express Tribune earlier this week said they anticipated a hike of 50 basis points in the policy rate. The SBP has cited fragile external flows along with rising inflation as primary reasons for the increase.



The recent increase comes after another hike of 50 basis points that the central bank announced back in September. Before increasing the rate by 100 basis points in the last two months, the SBP had reduced the same by as many as 500 basis points over a period of two years from its peak of 14% in June 2011.

According to the SBP, an increase in inflation while keeping the market interest rates at the current level would have increased the incentive for borrowings on the one hand and discouraged savings in the economy, on the other.

“With fragile external flows, negative real return can encourage outflow of foreign exchange, increasing the pressure on the exchange rate,” the SBP noted in its monetary policy statement.

Had the central bank maintained the discount rate at 9.5%, the possibility of a negative real interest rate in the economy, whereby the inflation rate surpasses the prevailing discount rate, would have been very real.

While Consumer Price Index (CPI) has been 8.3% in the first four months of fiscal year 2013-14, analysts at Topline Securities believe CPI will remain between 10%-10.5% in the current fiscal year. “That is why another 50 basis points rise in the policy rate is expected in the second half of fiscal 2014,” Topline Securities research analysts Zeeshan Afzal said after the policy announcement.

Interestingly, the SBP in its latest policy statement says it expects CPI to remain in the range of 10.5%-11.5% in the current fiscal year as opposed to its previous estimate of 11%-12%.

Speaking to The Express Tribune, Standard Chartered Bank Senior Economist, Sayem Ali, welcomed the interest rate hike, hoping that it will result in slowing down the pace of the rupee depreciation. “The State Bank has made a good move. It will stop the sharp acceleration in inflation and support the rupee,” he said, adding that his bank anticipates further hike in the next monetary policy announcement due in January.

The SBP acknowledged that the deterioration in the external accounts has continued in fiscal year 2014 largely on account of weak financial inflows. The external current account had a deficit of $1.2 billion in the first quarter of the ongoing fiscal year. Moreover, the financial account balance had a net outflow of $68 million. Taking into account substantial repayments to the International Monetary Fund (IMF), the SBP reserves have declined by $1.3 billion during the July-September quarter. As of November 1, the SBP reserves stand at $4.2 billion.

However, notwithstanding the rate hike, Afzal believes the pressure on the rupee will continue because foreign exchange reserves are declining at a quick pace.

Published in The Express Tribune, November 14^th, 2013.

Like Business on Facebook, follow @TribuneBiz on Twitter to stay informed and join in the conversation.