KARACHI - The State Bank of Pakistan raised its key interest rate to 12.25 percent on Monday, warning that already soaring inflation risked further rises on the back of higher oil prices and reforms required for a bailout from the International Monetary Fund.

The 150 basis points increase follows a preliminary agreement last week with the IMF for a $6 billion loan that is expected to come with tough conditions, including raising more tax revenues and putting up gas and power prices. It was the eighth time the central bank has increased its main policy rate since the start of last year.

The SBP said that its estimates show that economic growth is expected to slow in fiscal year 2018-19 but will rise modestly in the fiscal year 2019-20. This slowdown is mostly due to lower growth in agriculture and industry. More than two-thirds of real GDP growth in financial year 2018-19 is expected to come from services.

Going forward, some gradual recovery in economic activity is expected on the back of improved market sentiment in the context of the IMF supported program, a rebound in the agriculture sector and government incentives for export-oriented industries, it said.

According to IMF forecast the economic growth is set to slow to 2.9 percent this year from 5.2 percent last year which will adds to pressure on Prime Minister Imran Khan – who came to power last year facing a balance of payments crisis that has now forced his government to turn to the IMF.

Higher prices for basic essentials including food and energy have already stirred public anger and the central bank suggested there was little prospect of any immediate improvement.

To capitalise on the worsening economic situation, the opposition parties are already engaged in consultation to launch a mass movement against the government. There are fears that the political instability in the existing situation would further deteriorate the economic conditions and bring more suffering to the people.

Inflation forecast

Noting average headline inflation rose to seven percent in the July-April period from 3.8 percent a year earlier, the central bank said in a statement that recent rises in domestic oil prices and the cost of food suggested that “inflationary pressures are likely to continue for some time”.

It said it expected headline inflation to average between 6.5 percent and 7.5 percent for the financial year to the end of June and was expected to be “considerably higher” in the coming year. Expected tax measures in next month’s budget as well as higher gas and power prices and volatility in international oil prices could push inflation up further, it said.

It said the fiscal deficit, which the IMF expects to reach 7.2 percent of gross domestic product (GDP) this year, was likely to have been “considerably higher” during the July-March period than in the same period a year earlier due to shortfalls in revenue collection, higher interest payments and security costs.

Despite some improvements, financing the current account deficit remained “challenging” and foreign exchange reserves of $8.8 billion were below standard adequacy levels at less than the equivalent of three months of imports.

A harsh budget ahead

Details of what Pakistan will be required to do under the IMF agreement, which must still be approved by the Fund’s board, have not been announced





but it is expected that the government would have to make some tough and politically difficult decisions to keep the economic ship afloat.

Besides the higher energy prices that will hit households hard, there are also expectations of new taxes and spending cuts in next month’s budget to reach a primary budget deficit - excluding interest payments - of 0.6 percent of GDP.

With the IMF forecasting a primary deficit of 2.2 percent for the coming financial year, that implies squeezing roughly $5 billion in extra revenues from Pakistan’s $315 billion economy, which has long suffered from problems raising tax revenue.



Forex situation

The value of rupee which has been on decline for past couple of years has seen a drastic dip in recent few days, touching a record low of 151 against the US dollar.

This devaluation has swelled country’s public debt and volume of interest payments, hit the development spending plans and stocked up inflation, besides creating many other troubles.

The central bank said it was watching foreign exchange markets closely and was prepared to take action to curb “unwarranted” volatility.

Repeating its stance over the issue, the bank said the recent movement in the rupee “reflects the continuing resolution of accumulated imbalances of the past and some role of supply and demand factors”.

However, it said, “[The] SBP will continue to closely monitor the situation and stands ready to take measures, as needed, to address any unwarranted volatility in the foreign exchange market.”



Some more details of SBP statement

Referring to the external sector, the central bank’s statement said the current account deficit narrowed to $9.6 billion in July-March 2018-19 as compared to a deficit of dollars 13.6 billion during the same period last year; a fall of 29 percent. The reduction is mainly driven by import compression and a healthy growth in workers’ remittances.

However, the impact of this positive movement was partially offset by higher international oil prices. The non-oil trade deficit declined from $13.7 billion in July-March of the financial year 2017-18 to $11.0 billion in July-March of financial year 2018-19 reflecting the impact of stabilization policies implemented so far.

Recent indicators suggest export volumes have begun to grow although total export receipts have not grown due unfavourable prices.

Moreover, the current level of reserves is below standard adequacy levels (equal to three months of imports cover). As noted in previous MPC statements, deep structural reforms are required to improve productivity and competitiveness of export-oriented sectors and improve the trade balance.

About fiscal sector, SBP said the overall fiscal deficit is likely to be considerably higher during July-March of fiscal year 2018-19. From a monetary policy perspective, a growing portion of the fiscal deficit has been financed through borrowings from SBP.

In absolute terms, the government borrowed Rs 4.8 trillion from SBP during 1st July- May 10 of financial year 2018-19, which is 2.4 times the borrowing during the same period last year. A major portion of this borrowing from the SBP (Rs 3.7 trillion) reflects a shift away from commercial banks which were reluctant to lend to the government at prevailing rates. The resulting increase in monetization of the deficit has added to inflationary pressures.

Regarding monetary sector and inflation outlook, it said that despite the recent tightening of monetary policy, private sector credit rose to 9.4 percent during the period of July 1 to May 10 fiscal year 2018-19. Much of the increase in credit was for working capital needs due to higher input prices.

The expansionary impact of higher government borrowing and private sector credit on broad money supply (M2) was partly offset by a contraction in net foreign assets of the banking sector. In aggregate, broad money supply grew by 4.7 percent during 1st July-May 10, fiscal year 2018-19.