Monetary policy: SBP maintains benchmark interest rate at 6%

KARACHI:

In line with the analysts’ expectation, the newly formed Monetary Policy Committee of the State Bank of Pakistan (SBP) decided on Saturday to keep the benchmark interest rate unchanged for the next two months.

A majority of analysts The Express Tribune polled had expected the SBP would keep the rate flat at 6%.

Announcing the decision of the Monetary Policy Committee at a press conference, SBP Governor Ashraf Wathra said real GDP is set to maintain last year’s growth momentum. “The uptick in economic activity appears to continue beyond 2015-16 on the back of energy and infrastructure projects under the China-Pakistan Economic Corridor (CPEC),” he said.

Central banks revise benchmark interest rates regularly to ensure price stability and help governments achieve economic growth targets.

The SBP expects average inflation in 2015-16 to remain between 3% and 4% in view of a benign outlook of global commodity prices, expectation of a moderate pickup in domestic demand and further ease in supply-side constraints like energy shortages. Global oil price trends and excess domestic food stocks may exert downward pressures on inflation, Wathra added.

Average inflation for the first six months of the fiscal year has been 2.1%, which is significantly lower than the government’s target for inflation at the beginning of the fiscal year. The SBP governor hastened to add that the trend in the year-on-year inflation has now reversed: inflation rose, albeit marginally, for the third consecutive month to 3.2% in December.

Interest rate vs discount rate

According to the revised interest rate corridor, the benchmark interest rate - often called policy or target rate - is 0.5% less than the discount rate. The discount rate is the ceiling rate at which commercial banks are allowed to borrow from the central bank’s discount window on an overnight basis.

The SBP brought down the policy rate by 300 basis points in 2014-15. It further reduced the target rate from 6.5% to 6% in its September announcement. However, it has opted for the status quo in the two bi-monthly monetary policy announcements since then.

Until now the board of directors of the central bank, which has the representation from the ministry of finance, would set the monetary policy direction. But following amendments to SBP Act 1956 under the current loan programme with the IMF, an independent Monetary Policy Committee has now been set up. The committee has three independent economists and no direct representative of the government.

Inflation expectations play a key role in the formulation of monetary policy. Central banks ‘tighten’ monetary policy by increasing the benchmark index rate when they expect upward inflationary pressures building up.

Expectations

Speaking to The Express Tribune, Topline Securities CEO Mohammed Sohail said a cut in the interest rate in coming months “cannot be ruled out” given the SBP’s expectation of low inflation for 2015-16. The SBP will have the option to revise the policy rate in March and May, as the fiscal year ends on June 30.

Wathra said Pakistan’s declining exports are reflective of a worldwide phenomenon. He said a reversal of trends in exports is dependent on external demand and international cotton prices. However, he added that easing of domestic constraints with the completion of ongoing energy projects could help improve export competitiveness.

According to Invest and Finance Securities CEO Muzammil Aslam, the fact that cotton production is at a record low this year does not bode well for the country’s exports, as textiles form its largest chunk.

“Price is a function of production. How will the exports increase if there is no surplus production to begin with?” he said.

Responding to a question, the SBP governor said Pakistan will soon reopen its banking channels with Iran. “We look forward to the removal of sanctions. But the interpretation of the removal of sanctions is not complete yet,” he added.

Published in The Express Tribune, January 31st, 2016.

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