Increase of SBP policy rate has come before time

M.Arif

SBP has announced its monetary policy on 26th January 2018 for the next two months and first time in the CY 2018. The rate has been increased by 25 bp making it 6.0%.
By this increase SBP looks to be in a hurry like political players in the country who are also in a hurry to make their presence visible.
However before going in to reasons for increase, let us see what SBP has to say on economic changes in the FY 2018.
n Fiscal deficit for H1-FY18 is expected to fall close to the last year’s 2.5 percent.
n Production of all major Kharif crops, except maize, has surpassed the level of FY17.
n Similarly, large scale manufacturing (LSM) recorded a healthy broad-based growth of 7.2 percent during Jul-Nov FY18 as compared to 3.2 percent during the same period last year
n GDP growth is projected to be around 5.8 percent, significantly higher than FY17, but marginally lower than the annual target of 6 percent for FY18. This is largely due to expectations of a below-target wheat crop because of a reduction in area under cultivation.
n Average headline inflation for H1-FY18 stands at 3.8 percent. Meanwhile, core inflation (non-food non-energy) continued to maintain its higher trajectory, and clocked in at 5.5 percent during the first half of the year as compared to 4.9 percent last year.
n Impact of PKR depreciation and rising international oil prices are likely to increase inflation in the coming months.
n However average inflation for FY18 is still projected to fall in the range of 4.5 to 5.5 percent at the end of fiscal year. YoY inflation is likely to inch towards the annual target of 6 percent.
n Broad money supply grew marginally by 1.9 percent during 1st Jul-12th Jan FY18. This is a reflection of the decline in NFA and government efforts to contain expenditures.
n Higher tax collection and proceeds from the issuance of Sukuk and Eurobond have led to reduction in net budgetary borrowing which stood at Rs. 401.9 billion during 1st Jul-12th Jan FY18 as compared to Rs. 470.4 billion in the corresponding period of the previous year.
n On the external front, export receipts posted the highest growth in the last seven years of 10.8 percent in H1-FY18 against a reduction of 1.4 percent in H1-FY17.
n Worker’s remittances also recorded growth (2.5 percent) during the first half of the year as compared to a decline in the same period last year.
n However, favorable impact of these positives was overshadowed by the continuation of strong growth in imports of goods and services. The current account deficit widened to US$ 7.4 billion during the first half of the year, which was 1.6 times of the deficit during the same period last year.
n Developments in financial accounts show that one-fifth of this deficit was financed by healthy foreign direct investments inflows, and the rest was managed by the official flows and the country’s own resources.
n SBP’s liquid foreign exchange reserves witnessed a decline of US$ 2.6 billion since end June 2017 to reach US$ 13.5 billion as of 19th January 2018.
n Going forward, the PKR depreciation in December 2017, the export package, the lagged impact of adjustments in regulatory duties, favorable external environment, and expected increase in workers’ remittances, will contribute to a gradual reduction in the country’s current account deficit.
n Increase in international oil prices pose a major risk to this assessment, managing overall balance of payments in near term depends on the realization of official financial flows.
Factors pointed out by the SBP for increase in policy rate are as follows.
1. Since November 2017 firstly PKR depreciated by around 5 percent.
2. Secondly, oil prices are hovering near USD 70 per barrel.
3. Thirdly, a numbers of central banks have started to adjust their policy rates upwards adversely affecting PKR interest-rate differentials Vis-à- Vis their currencies.
4. Fourthly, multiple indicators show that the output gap has significantly narrowed indicating a buildup of demand pressures.
5. Overheating of the economy has started with rise of inflation breaching its target rate.
Now talking of external sector the situation stands entirely different. Despite numerous efforts, exports volumes and remittances inflow remained inadequate to finance the imports payments. “Current Account deficit widened further, which along with insufficient inflows, resulted in reserves drawdown”.
Money Market moves have also fueled anxiety for an interest rate hike in the financial circles. To some circles these dynamics were instrumental in firming up expectations of an interest rate hike in the interbank market.
However before announcement generally the State Bank of Pakistan (SBP) was expected to leave the key interest rate unchanged at 5.75% for the time being. Anticipating gradual mounting inflationary pressures from January onwards majority of the houses foresee the first interest rate hike may take place in March’s MPS in the range of 25-50 basis points.
In spite of this market was also showing a cautious attitude in its activities. Money Market investors continued to remain aloof from committing long-term. Of the last three T-Bill Auctions held on 17th, 3rd of January and 20th December Government of Pakistan received zero bids for the six month and one year targets. All of the bids were concentrated in the 3-month T-bills, revealing a very cautious approach from investors who continue to observe the macroeconomic situation under a microscope.
Keeping all of the above fundamentals in view it was safe to assume that the SBP still had some breathing space to delay a rate hike till March 2018. Inflation has been rising since July, 2017 at a relatively smooth pace, however the real interest rates were showing a comfortable level i.e. Staying within the set target at an average of 6% for fiscal year 2018. In addition to that as reported for the private sector credit off take on 12th January 2018 as Rs 201.2 billion as of July 2017 to 12th January 2018 as compared to Rs273.4 in the preceding year also bolsters the need for an unchanged policy rate for the time being. But the pressures on the external front continue to mount, with the rising imports and snail-paced increase in remittances, Pakistan will have to look for avenues to raise funds in order to finance the gap. This is going to jump for government sector borrowing mostly from the external sector. In this respect CPEC has to play an important role. Let us see how Tariq Bajwa in SBP and Miftah in Finance Ministry deal with such complicated situation.

Chairman Centre of Advisory Services for Islamic Banking and Finance (CAIF), former Member of IFSB on Islamic Money Market, former Head of FSCD SBP, former Head of Research Arif Habib Investments, former Member of Access to Justice Funds Supreme Court of Pakistan Member visiting Faculty/ KASBIT/BIZTEK/Sheikh Zayed Institute University of Karachi/PAF KIET/MAJU