In line with market expectations, Pakistan’s central bank on Friday left the benchmark interest rate unchanged at 7% for the next two months to support growth momentum in the national economy. More importantly, the bank hinted at maintaining the benchmark interest rate at the current level in its next bimonthly monetary policy statement (MPS) scheduled for July 27, 2021 to support economic activities which were at risk due to the ongoing third wave of the Covid-19 pandemic.
Since its previous meeting in March, the Monetary Policy Committee (MPC) of the central bank had been encouraged by the upward revision in the FY21 economic growth forecast to 3.94% compared to the State Bank of Pakistan’s (SBP) projection of 3% growth. “The MPC noted that this confirms the strength of the broad-based economic rebound underway since the start of the fiscal year, on the back of targeted fiscal measures and aggressive monetary stimulus,” the SBP said in a statement. “This positive momentum is expected to persist, translating into higher growth next year.”
The central bank has kept the rate at 7% for the fifth consecutive time in the past 11 months (July-May FY21) despite the fact that average inflation reading for the outgoing fiscal year is expected to reach close to the upper limit of its 7-9% projection. Inflation is likely to soar due to increase in electricity prices in February coupled with the hike in food item prices during Ramazan. Accordingly, the real interest rate (benchmark interest rate minus inflation) remained negative at around 2%.
“On a sequential basis, upward momentum in certain food prices - notably fresh fruits, vegetables, dairy, poultry and edible oil - was exacerbated by the advent of Ramazan, more than offsetting the recent decline in wheat prices,” the SBP said. The central bank slashed the benchmark interest rate by 625 basis points to 7% during March-June 2020. The reduction was made to protect business and economic activities from the impact of Covid-19 pandemic, which emerged in the country in February 2020. The interest rate is a tool available with central banks around the world to control inflation in their respective economies.
The State Bank’s MPC, headed by Governor Reza Baqir, noted that keeping the interest rate at current level was appropriate to support economic activities, which were at risk of the ongoing third wave of Covid-19 pandemic. Secondly, the committee noted that the increase in inflation reading close to the upper limit of SBP’s projection was due to shortage in supply of food items and power tariff hike instead of a surge in demand for goods and power. Accordingly, the benchmark interest has nothing to do with the surge in inflation reading.
Instead, it is the job of the government to remove supply constraints on goods to control inflation. “Looking ahead, in the absence of unforeseen circumstances, the MPC expects monetary policy to remain accommodative in the near term (next MPC meeting in July), and any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rate over time,” the SBP said. “If demand-side pressures emerge as the recovery becomes more durable and the economy returns to full capacity, the MPC noted that it would be prudent for monetary policy to begin to normalise through a gradual reduction in the degree of accommodation,” it said.
“This would help ensure that inflation does not become entrenched at a high level and financial conditions remain orderly, thereby supporting sustainable growth.” As the economy gathers further momentum, it will be important to ensure that food price pressures are reversed through successful implementation of administrative measures to keep secondround effects in check. “Looking ahead, the inflation trajectory will be affected by the path of domestic food and energy prices, this summer’s round of wage negotiations, next year’s budget and the strength of the ongoing economic recovery,” the central bank said.
“As supply shocks dissipate thereafter, inflation is expected to gradually fall towards the 5-7% target range over the medium term,” the SBP statement read. The latest National Accounts Committee data confirms that the economy has rebounded strongly to 3.98% from last year’s severe Covid shock, led by services and industry. The industrial sector is estimated to have grown 3.6% during FY21, driven by construction and large-scale manufacturing, especially food, cement, textile and automobile sectors.
The agriculture sector is estimated to have grown 2.8%, with the production of three important crops - wheat, rice and maize - rising to record highs and that of sugarcane to its second-highest level. Services are estimated to have rebounded from last year’s contraction to register a growth of 4.4%, led by wholesale and retail trade.