ISLAMABAD    -    The State Bank of Pa­kistan (SBP) in an ex­pected move has in­creased the interest rate by three percent to 20 percent in or­der to fulfil the pri­or actions of the In­ternational Monetary Fund (IMF) for reviv­ing the much needed loan programme.

The Monetary Poli­cy Committee (MPC) of the SBP decided to in­crease the policy rate to 20 percent, the high­est level since October 1996 in an attempt to "anchor inflation expec­tations as it is critical and warrants a strong policy response”. This was one of the prior actions of the IMF for revival of loan programme for Pakistan.

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 materialized 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 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 em­phasized that anchoring inflation expec­tations is critical and warrants a strong policy response.

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 percent 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 MPC noted that FX reserves remain low and concerted efforts are needed to improve the external position. In this regard, con­clusion of the ongoing 9th review under the IMF’s EFF will help address near-term external sector challenges. Further­more, the MPC stressed on the urgent need for energy conservation measures to alleviate pressure on the external ac­count and meet the import requirements of other sectors. 

The recent fiscal measures – including an increase in GST and excise duties, re­duction in subsidies, adjustments in en­ergy prices, and the austerity drive – are expected to help contain the otherwise widening fiscal and primary deficits. 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 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. The Committee views that the risks to financial stability remain con­tained, given that financial institutions are broadly well capitalized. On growth, however, there exists at 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 this fresh 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 5–7 percent by end-FY25.