ISLAMABAD – State Bank of Pakistan (SBP) Friday announced the monetarypolicy for next two months, decided to increase the policy rate by 50 basicpoints (bps) to 10.75 percent which would be effective from April 1, 2019.
The Monetary Policy Committee (MPC) noted that sustainable growth andoverall macroeconomic stability requires further policy measures asunderlying inflationary pressures to continue, the fiscal deficit iselevated, and despite an improvement,the current account deficit is stillhigh, a SBP press release said.It said economic data released since the last MPC meeting in January 2019indicates that the impact of stabilization measures continues to unfold.
In particular, the current account deficit recorded a sizeable contractionduring the first two months of 2019, which, together with bi-lateralinflows, helped ease pressures on SBP’s foreign exchange reserves.
These developments on the external front have improved stability in thefinancial markets, reduced uncertainty and improved businesses confidence,as reflected in various surveys.Nonetheless, despite narrowing, the current account deficit remains high,fiscal consolidation is slower than anticipated, and core inflationcontinues to rise.
Average headline CPI inflation reached 6.5 percent in Jul-February offiscal year 19 compared to 3.8 percent recorded in the same period lastyear. Meanwhile, year on year CPI inflation has risen considerably to 7.2percent in January 2019 and further to 8.2 percent in February 2019- thehighest YoY increase in inflation since June 2014.
These pressures on headline inflation are explained by adjustments in theadministered prices of electricity and gas, significant increase inperishable food prices, and the continued unfolding impact of exchange ratedepreciation.Core inflation maintained its 13-month upward trajectory accelerating to8.8 percent in February 2019 from 5.2 percent a year earlier. Further,rising input costs on the back of higher energy prices and the laggedimpact of exchange rate depreciation are likely to maintain upward pressureon inflation despite a moderation in aggregate demand due to a proactivemonetary management. As a result, headline CPI inflation is projected tofall in the range of 6.5 to 7.5 percent for FY19.
Amidst the efforts to curtail inflationary pressures and reduce theotherwise widening macroeconomic imbalances, domestic economic activityexperienced the brunt of the stabilization measures implemented thus far.
In particular, Large-scale Manufacturing (LSM) declined by 2.3 percentduring Jul-Jan FY19 against 7.2 percent growth recorded in the same periodlast year. The latest available estimates of major crops also depict alackluster performance by the agriculture sector.The slowdown in commodity producing sectors has downside implications forgrowth in services sector as well.
Similarly, a deceleration in consumer demand and capital investments,reflected through a cut in development spending and deceleration in creditfor fixed investments, indicates a moderation in domestic demand. In thisbackdrop, the real GDP growth is projected to be around 3.5 percent in FY19.
Owing to stabilization measures, the current account deficit narrowed toUS$ 8.8 billion in Jul-Feb FY19 compared to a deficit of US$ 11.4 billionduring the same period last year- a fall of 22.6 percent.
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This includes a notable pace of retrenchment of the current account deficitby 59.9 percent during the first two months of 2019 over the same periodlast year.
This reduction in the external balance was mainly driven by a 29.7 percentdecline in the trade deficit in goods and services as well as a stronggrowth in remittances. The reduction in the trade deficit is in large partdriven by import compression- this decline would have been even morepronounced if not for a rise in oil prices. Exports, in dollar value,during this period remained flat, however in terms of quantum there hasbeen a notable improvement.
Though still posing a significant challenge in term of its financing, thenarrowing of the current account deficit has translated into some stabilityin the foreign exchange market.
With an improvement in the external balance as well as an increase inbilateral official inflows, SBP’s foreign exchange reserves graduallyrecovered to US$ 10.7 billion on 25th March 2019.While the reserves are still below the standard adequacy levels (equal tothree months of imports cover), the recent improvement on the externalfront has nevertheless improved business confidence.
This is captured in the recent wave of IBA-SBP surveys of large number offirms in industry and services sectors. Having said that, the share ofprivate financial flows need to increase on sustainable basis to achievemedium-to-long term stability in the country’s external accounts.Similarly, as enunciated in previous statements, concerted structuralreforms are required to reduce the trade deficit by improving productivityand competitiveness of the export-oriented sectors.
The fiscal deficit for HI-FY19 was higher at 2.7 percent of GDP whencompared with 2.3 percent for the same period last year. In view of theshortfalls in revenue collections and escalating security-relatedexpenditures it is most likely that the target for the fiscal deficit inFY19would be breached.
So far, a significant portion of the fiscal deficit was financed throughborrowings from SBP, which if continued, will not only complicate thetransmission of monetary policy but also dilute its impact and prolong theongoing consolidation efforts.
In absolute terms, the government borrowed Rs3.3 trillion from SBP andretired Rs2.2 trillion of its borrowing from scheduled banks (on cashbasis) during July 1 to Mar 15, of FY19. This in turn, facilitated thebanks to meet private sector credit demand th
