Monetary Policy Statement

At today’s meeting, the Monetary Policy Committee (MPC) decided to maintain the policy rate at 9.75 percent. This decision reflected the MPC’s view that the outlook for inflation has improved following the cuts in fuel prices and electricity tariffs announced last week as part of the government’s relief package. At the same time, high-frequency indicators suggest that growth continues to moderate to a more sustainable pace. This moderation should help keep at bay demand-side pressures on inflation and contain non-oil imports, notwithstanding the significant uncertainty about the future path of global energy and food prices due to the Russia-Ukraine conflict.
Since the last MPC meeting on 24th January 2022, headline inflation moderated in February to 12.2 percent (y/y). Inflation in February would have been noticeably lower were it not for abnormal increases in a few perishable items. Accordingly, core inflation also fell in urban areas and inflation expectations have remained stable, suggesting that second-round effects from higher commodity prices remain contained. On the external front, despite the rise in global prices, the February trade deficit witnessed a further 10 percent contraction (m/m) on top of the 29 percent decline recorded in January, confirming the slowdown in domestic demand. While the current account deficit rose in January, this largely reflected lumpy imports of oil, vaccines and other items financed through loans and supplier credit. Excluding these imports, the deficit would have been about $1 billion lower, suggesting that the underlying trend in the current account balance is also moderating.
Looking ahead, the MPC noted that while current real interest rates on a forward-looking basis are appropriate to guide inflation to the medium-term range of 5-7 percent, support growth, and maintain external stability, the Russia-Ukraine conflict has introduced a high degree of uncertainty in the outlook for international commodity prices and global financial conditions. Continued adverse conditions on these fronts could pose challenges to the outlook for the current account deficit and inflation expectations, which could necessitate changes in the policy rate. Since the Russia-Ukraine situation remains fluid, the MPC noted that it was prepared to meet earlier than the next scheduled MPC meeting in late April, if necessary, to take any needed timely and calibrated action to safeguard external and price stability.
In reaching its decision, the MPC considered key trends and prospects in the real, external and fiscal sectors, and the resulting outlook for monetary conditions and inflation.

Real sector

Growth continues to moderate on the back of high prices and demand-easing measures. Since the last meeting, automobile sales and electicity generation have declined month-on-month. Sales of petroleum products and cement have also decelerated since last October. In the second quarter of FY22, growth in fast-moving consumer good (FMCG) sales dipped and general sales tax collections from services were lower than last year. On the supply side, LSM growth has been revised upward following the rebasing, settling at around 5-6 percent (y/y) since October. Agricultural prospects have somewhat weakened, with key inputs such as fertilizer off-take and water availability during the Rabi season lower than last year. Cotton and wheat production will likely be less than previous estimates. Growth in FY22 is still expected around the middle of the previously forecast range of 4-5 percent.

External sector

In January, there was a sharp and broad-based decline in imports, including energy imports, to $6.1 billion from $7.6 billion in December based on PBS data. Imports declined further in February while exports rose, resulting in a 38 percent contraction in the trade deficit compared to its peak last November. Around three-fourths of the rise in imports this year is estimated to stem from higher prices, with the contribution from volume growth negative in January. These trends suggest that demand-led pressures on the current account are declining. While the current account deficit rose to $2.6 billion, this included a sizeable contribution from imports financed through loans and supplier credit, including oil and vaccines. Since these imports are concurrently financed with offsetting inflows in the capital and financial account, they do not undermine sustainability of the current account. Remittances fell marginally in January, partly reflecting seasonality, but have grown in line with expectations so far this fiscal year. Looking ahead, the non-oil current account deficit is expected to decline, as import growth continues to slow with moderating demand, while exports and remittances remain resilient. The outlook for the overall current account deficit is dependent on the path of international oil prices.

Fiscal sector

At around 2 percent of GDP, the fiscal deficit during the first half of FY22 was almost the same as last year. FBR tax collections grew strongly by 30 percent (y/y) during Jul-Feb FY22, in part due to a depreciated exchange rate and higher imports than last year as well as strengthened tax collection efforts. This offsets declines in non-tax revenues due to lower petroleum development levy revenues and increased spending, including on subsidies, grants and provincial PSDP. While the primary balance posted a surplus of 0.1 percent of GDP in the first half of FY22, it was lower than the surplus of 0.6 percent of GDP in the same period last year. Under the assumption that the recently announced relief package will not add to the fiscal deficit due to other offsetting savings, inflation should be lower through the rest of the fiscal year than earlier estimated.

Monetary and inflation outlook

Private sector credit saw a net retirement in January in line with seasonal patterns, and broad money growth also decelerated. Automobile and personal loans slowed further due to tightening of prudential regulations and increased borrowing costs. On the other hand, demand for loans for fixed investment and housing and construction continued to grow. Monetary conditions remain tighter in real terms, with private sector credit growth in negative territory.
Headline inflation fell from 13 percent (y/y) in January to 12.2 percent in February, driven by a slowdown in energy price inflation. The contribution to inflation from food prices rose, reflecting higher prices for tomatoes, fresh vegetables, chicken, and vegetable ghee. Meanwhile, core inflation ticked down in urban areas and up in rural areas, while inflation expectations of both consumers and businesses remained broadly unchanged. The MPC continues to expect inflation to average between 9-11 percent this fiscal year before declining toward the medium-term target range of 5-7 percent in FY23 as global commodity prices normalize. This baseline outlook is subject to risks from the path of global prices, domestic wage developments, and the fiscal policy stance. The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth.

At today’s meeting, the Monetary Policy Committee (MPC) decided to raise the policy rate by 100 basis points to 9.75 percent. The goal of this decision is to counter inflationary pressures and ensure that growth remains sustainable.

Since the last meeting on 19th November 2021, indicators of activity have remained robust while inflation and the trade deficit have risen further due to both high global prices and domestic economic growth. In November, headline inflation increased to 11.5 percent (y/y). Core inflation in urban and rural areas also rose to 7.6 and 8.2 percent, respectively, reflecting domestic demand growth. On the external side, despite record exports, high global commodity prices contributed to a significant increase in the import bill. As a result, the November trade deficit rose to $5 billion based on PBS data.

The MPC noted that recent data releases confirm that the emphasis of monetary policy on moderating inflation and the current account deficit remains appropriate. Following today’s rate increase and given the current outlook for the economy, and in particular for inflation and the current account, the MPC felt that the end goal of mildly positive real interest rates on a forward-looking basis was now close to being achieved. Looking ahead, the MPC expects monetary policy settings to remain broadly unchanged in the near-term.

In reaching its decision, the MPC considered key trends and prospects in the real, external and fiscal sectors, and the resulting outlook for monetary conditions and inflation.

Real sector

High-frequency indicators of domestic demand released since the last meeting, including electricity generation, cement dispatches, and sales of fast-moving consumer goods and petroleum products, and continued strength in imports and tax revenues suggest that economic growth remains robust. The outlook for agriculture continues to be strong, supported by better seed availability and an expected increase in the area under wheat cultivation. Meanwhile, robust growth in sales tax on services also suggests that the tertiary sector is recovering well. While some activity indicators are moderating on a sequential basis, partly as a result of recent policy actions to restrain domestic demand, growth this fiscal year is expected to be close to the upper end of the forecast range of 4-5 percent. This projection factors in the expected impact of today’s interest rate decision. The emergence of the new Coronavirus variant, Omicron, poses some concerns, but at this stage there is limited information about its severity. The MPC noted that Pakistan had successfully coped with multiple waves of the virus, which supported a positive outlook for the economy.

External sector

Despite strong exports and remittances, the current account deficit has increased sharply this year due to a rise in imports, and recent outturns have been higher than earlier expected. Based on PBS data, imports rose to $32.9 billion during July-November FY22, compared to $19.5 billion during the same period last year. Around 70 percent of this increase in imports stems from the sharp rise in global commodity prices, while the rest is attributable to stronger domestic demand. Due to the higher recent outturns, the current account deficit is projected at around 4 percent of GDP, somewhat higher than earlier projected. While in the near term monthly current account and trade deficit figures are likely to remain high, they are expected to gradually moderate in the second half of FY22 as global prices normalize with the easing of supply disruptions and tightening of monetary policy by major central banks. In addition, recent policy actions to moderate domestic demand―including policy rate hikes and curbs on consumer finance―and proposed fiscal measures, should help moderate growth in import volumes through the rest of the year.

In this context, the MPC emphasized that the monetary policy response to arrest the deterioration in the current account deficit has been timely. Together with the natural moderating influence of the flexible and market-determined exchange rate, the MPC felt that this response would help achieve the goal of a sustainable current account deficit this fiscal year. Moreover, the MPC noted that the current account deficit is expected to be fully financed from external inflows. As a result, foreign exchange reserves should remain at adequate levels through the rest of the fiscal year and resume their growth trajectory as global commodity prices ease and import demand moderates.

Fiscal sector

During July-November FY22, fiscal revenue growth has been strong, driven by a broad-based and above-target increase in FBR tax collections (36.5 percent (y/y)). However, lower petroleum development levy (PDL) collection led to a decline in non-tax revenues (22.6 percent (y/y) in Q1 FY22). On the expenditure side, development spending and subsidies and grants have increased significantly during this period. The government intends to introduce legislation to increase revenues through elimination of certain tax exemptions and reduce current and development expenditures. These measures would help moderate domestic demand, improve the current account outlook, and complement recent monetary policy actions.

Monetary and inflation outlook

Since the last meeting, despite a moderation in consumer loans, overall credit growth has remained supportive of growth. Meanwhile, across all tenors, secondary market yields, benchmark rates and cut-off rates in the government’s auctions have risen significantly. The MPC noted that this increase appeared unwarranted.

The momentum in inflation has continued since the last MPC meeting, as reflected in a significant increase in both headline and core inflation in November. Due to recent higher than expected outturns, SBP expects inflation to average 9 – 11 percent this fiscal year. The pick-up in inflation has been broad-based, with electricity charges, motor fuel, house rent, milk and vegetable ghee among the largest contributors. On a sequential basis, inflation rose 3 percent (m/m) in November. Looking ahead, based on this momentum and the expected path of energy tariffs, inflation is likely to remain within the revised forecast range for the remainder of the fiscal year. Subsequently, as global commodity prices retrench, administered price increases dissipate, and the impact of demand-moderating policies materializes, inflation is expected to decline toward the medium-term target range of 5-7 percent during FY23. The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability and growth.