The Monetary Policy Committee of the State Bank of Pakistan has raised the key interest rate by 300 basis points, as it believes this outlook warrants a strong policy response to anchor inflation expectations around the medium-term target of 5 to 7 per cent.

“At its meeting held on 2nd March 2023, the MPC decided to increase the policy rate by 300 basis points to 20%,” it said.

The key rate of the State Bank of Pakistan now stands at 20%, its highest level since October 1996. In its last policy meeting in January the bank raised the rate by 100 bps to 17%. It has now raised rates by a total of 1,025 bps since January 2022.

“During the last meeting in January, the Committee had highlighted near-term risks to the inflation outlook from external and fiscal adjustments. Most of these risks have materialised and are partially reflected in the inflation outturns for February. The national CPI inflation has surged to 31.5 percent y/y, while core inflation rose to 17.1 percent in urban and 21.5 percent in rural basket in February 2023.”

The MPC statement said that in today’s meeting, the committee noted that the recent fiscal adjustments and exchange rate depreciation have led to a significant deterioration in the near term inflation outlook and a further upward drift in inflation expectations, as reflected in the latest wave of surveys.

“The Committee expects inflation to rise further in the next few months as the impact of these adjustments unfolds before it begins to fall, albeit at a gradual pace.

“The average inflation this year is now expected in the range of 27 - 29 percent against the November 2022 projection of 21 – 23 percent. In this context, the MPC emphasised that anchoring inflation expectations is critical and warrants a strong policy response.”

To know how it will impact you read this.

On the external side, the MPC noted that despite a substantial reduction in the current account deficit (CAD), “vulnerabilities continue” to persist.

In January 2023, the CAD fell to $242 million, the lowest level since March 2021. Cumulatively, the CAD – at $3.8 billion in Jul-Jan FY23 – is down 67 per cent compared to the same period last year.

“Notwithstanding this improvement, scheduled debt repayments and a decline in financial inflows amid rising global interest rates and domestic uncertainties, continue to exert pressure on FX reserves and the exchange rate.” The committee noted that foreign reserves “remain low” and concerted efforts are needed to improve the external position. It was of the view that conclusion of the ongoing ninth review under the IMF’s EFF would help address near-term external sector challenges. Furthermore, the MPC stressed the need for energy conservation measures to alleviate pressure on the external account and meet the import requirements of other sectors.

Recent fiscal measures – including an increase in GST and excise duties, reduction in subsidies, adjustments in energy prices, and the austerity drive – were expected to help contain the otherwise widening fiscal and primary deficits, it added. “As highlighted in earlier statements, the envisaged fiscal consolidation is critical for economic stability and will complement the ongoing monetary tightening in bringing down inflation over the medium-term,” the committee said and emphasized that any significant fiscal slippages will undermine monetary policy effectiveness in the context of achieving the price stability objective.

The MPC also assessed the impact of further monetary tightening on financial stability and the near-term growth outlook. It went on to add that the risks to financial stability remain contained, given that financial institutions were broadly well capitalized. “On growth, however, there exists a trade-off. The MPC, nonetheless, reiterated its earlier view that the short-term costs of bringing down inflation are lower than the long-term costs of allowing it to become entrenched. Barring unexpected future shocks, the MPC noted that today’s decision has pushed the real interest rate in positive territory on a forward-looking basis. This will help anchor inflation expectations and steer inflation to the medium-term target of 5 to 7 per cent by endFY25.”