Upside Risks to Inflation Outlook Increase, Prompting Policy Rate Hike

By | June 26, 2023

The State Bank of Pakistan (SBP) stated that the MPC discussed the rising potential risks to the inflation outlook since its last meeting on June 12. The committee emphasized that these risks primarily stem from the implementation of new measures in the fiscal and external sectors. These measures are crucial in the context of completing the ongoing International Monetary Fund (IMF) program.

The MPC acknowledged that taking action at this time is necessary to maintain a positive real interest rate and proactively address inflation. By doing so, it aims to achieve the medium-term inflation target of five to seven per cent by the end of fiscal year 2025. The SBP highlighted this in its statement.

Increased Upside Risks from Domestic Developments

According to the press release issued by the SBP, two significant domestic developments have slightly worsened the inflation outlook since the June 12 meeting. These developments could potentially add pressure to the already strained external account.

Firstly, the National Assembly approved certain upward revisions in taxes, duties, and the petroleum development levy rate for the FY24 budget on June 25. Secondly, the SBP withdrew its general guidance to commercial banks on import prioritization on June 23.

While the MPC considers these measures necessary for completing the IMF program, it acknowledges that they have increased the upside risks to the inflation outlook.

Impact on Inflation and Foreign Exchange Market

The MPC believes that the additional tax measures in the approved budget will likely contribute to inflation, both directly and indirectly. Furthermore, the relaxation of import regulations may exert pressure on the foreign exchange market. This pressure could result in a higher-than-anticipated exchange rate pass-through to domestic prices.

Given these considerations, the MPC decided to raise the policy rate by 100 basis points. The committee views this action as crucial for maintaining a positive real interest rate in the future.

Anchoring Inflation Expectations and Reducing Economic Uncertainty

The MPC believes that this decision will further anchor inflation expectations, which have already been moderating over the past few months. It will also support the objective of reducing inflation to the medium-term target of 5-7 per cent by the end of FY25, barring any unforeseen developments.

In addition, the committee stated that today’s decision, along with the expected completion of the ongoing IMF program and the government’s commitment to generating a primary surplus in FY24, will address external sector vulnerabilities and reduce economic uncertainty.

The MPC reiterated its commitment to carefully monitoring evolving economic developments. If necessary, it stands ready to take appropriate action to achieve price stability over the medium term.

IMF Approval Awaited

After revising the budget to align with the IMF’s demands, the government anticipates an imminent announcement from the global lending agency regarding the much-needed bailout funds.

An official stated that nearly all the issues between the IMF staff and the Ministry of Finance were resolved shortly before the finance minister’s concluding speech on Saturday. The official further mentioned that the announcement of the successful completion of the ninth review is now merely a formality and a privilege of the IMF.

While the precise dates for the IMF’s executive board approval and fund disbursement are yet to be determined, the official acknowledged that it is not scheduled before June 30. This date marks the expiration of the $6.5 billion Extended Fund Facility agreed upon in 2019.

The revised budget incorporates additional tax measures amounting to Rs215 billion, a spending cut of Rs85 billion, the removal of a foreign exchange inflow amnesty, the lifting of import restrictions, a Rs16 billion increase in Benazir Income Support Programme allocations, and the authority to raise the petroleum levy from Rs50 to Rs60 per litre.

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