Change in interest rate

The SBP has surprised many pundits by raising its policy rate by 25 basis points, taking it to 7.25% for October and November. The SBP, like central banks across the world, had begun cutting their rates last March in response to the Covid-19 pandemic.

The aim was to encourage economic activity to offset the impact of lockdowns around the world. After a series of cuts, the rate fell to 7% in June 2020, where it has remained since then. Publically, the SBP is saying that it is hiking the interest rate because “the pace of the economic recovery has exceeded expectations”, and the economy is less vulnerable to “pandemic-related uncertainty”.

It also says that its goals have shifted from catalysing a recovery to sustaining it. This may be true, but we must note that several other countries seeing solid rebounds have not changed their rates. However, the SBP’s second reason seems to be the real story — the rising current account deficit being fueled by a spike in imports. The import spike also caused the rupee to fall to record low levels before improving slightly. Interestingly, the bank tried to pass some responsibility for the rupee’s decline to policy announcements by the US Federal Reserve — America’s central bank — although it did admit the need to check imports and grow exports.

Inflation also remains a problem for many citizens, even though the SBP insists that core inflation actually fell. A rate hike could help bolster the rupee value while also eating into inflation. However, as the central bank also notes, real interest rate remains negative, so it is unlikely that the rate cut would hit growth too heavily. The central bank believes that growth targets will not be heavily impacted by the “greater uncertainty” caused by the “evolving situation in Pakistan”.

This may veer towards unfounded optimism. We have already seen the first, very public fallout from the Afghanistan situation as foreign cricket teams canceled their Pakistan tours. While the cancellations may only add up to a few million dollars in potential revenue losses, their non-sporting impact, especially on tourism and business travel, could be significant.