State Bank of Pakistan’s (SBP) Monetary Policy Committee (MPC) met today, on 4th April 2023, and agreed to hike the policy rate by 1%. With the latest revision, the policy rate has reached 21%, a new record high.
Experts were also expecting a 1-2% hike. “Pakistan's central bank looks set to raise its key interest rate by 200 basis points to a record high of 22% at its review on April 4, as it struggles to bring down stubborn inflation, the median estimate in a Reuters Poll showed,” Reuters reported.
The expectation is due to the unprecedented inflationary pressure which the country is currently facing. For March 2023, consumer price inflation exceeded 35%, the highest in the last 50 years.
Ailment of inflation and the cure of interest rate
Pakistan is facing a wave of cost-push inflation driven by relatively inelastic imports of fuel and food items, making experts question the effectiveness of increasing interest rates. Successive rate hikes have squeezed consumer discretionary demand, leaving no room for further contractionary measures. Inflationary expectations from suppliers and consumers are further driving prices up, leading to hoarding and premium selling.
Moreover, raising interest rates may not lead to greater savings due to the existence of a significant parallel economy in the country. This economy is not documented and does not respond systematically to monetary measures. While SBP’s policy of keeping negative real interest rates for over three years and pumping money into the system has also resulted in over Rs 8 trillion in circulation, which accounts for almost 20% of the GDP. This further undermines the efficacy of raising interest rates as tool to bring grey cash into the formal economy, adding to inflation.
“At this point in time, tightening policy further is not the answer to inflation or macroeconomic stability. Consumer discretionary demand has already cratered as is evident from high frequency indicators and the cash/undocumented economy does not materially respond to rate hikes,” tweeted Mustafa Pasha, Chief Investment Officer at Lakson Investments Limited.
“Rather focus on continued fiscal adjustments, increasing revenue (by taxing trade, agri, real estate) ending pointless subsidies/tariffs & privatising SOEs. Productivity is the answer, not breaking people to the point where they have to forgo feeding their families,” he added.
Higher interest rates will also make debt servicing an even bigger challenge for the government, as interest expenses have surged significantly. According to the fiscal operations data released for the first eight months of the current fiscal year, Pakistan's interest expenses have surged significantly to Rs 3.18 trillion, which accounts for 81% of the annual debt servicing budget. Further, as per the government’s expectation debt servicing costs may reach nearly Rs 5.2 trillion this fiscal year, which is more than half of the total budget.
However, it looks like the SBP has to resort to hiking the policy to send a strong signal to the market and to satisfy the IMF.
As per a recent editorial published by the Business Recorder, “Any increase in rates to exacerbate the problem would increase the chances of domestic debt restructuring, which could be a nightmare. Thus, higher increase repercussions could surpass benefits. But it’s necessary to send a strong signal across. That is why the doctor’s prescription is to go with the market’s expectation of 1-2 percent increase. And that is perhaps what satisfies the IMF as well.”
Experts were also expecting a 1-2% hike. “Pakistan's central bank looks set to raise its key interest rate by 200 basis points to a record high of 22% at its review on April 4, as it struggles to bring down stubborn inflation, the median estimate in a Reuters Poll showed,” Reuters reported.
The expectation is due to the unprecedented inflationary pressure which the country is currently facing. For March 2023, consumer price inflation exceeded 35%, the highest in the last 50 years.
Ailment of inflation and the cure of interest rate
Pakistan is facing a wave of cost-push inflation driven by relatively inelastic imports of fuel and food items, making experts question the effectiveness of increasing interest rates. Successive rate hikes have squeezed consumer discretionary demand, leaving no room for further contractionary measures. Inflationary expectations from suppliers and consumers are further driving prices up, leading to hoarding and premium selling.
Moreover, raising interest rates may not lead to greater savings due to the existence of a significant parallel economy in the country. This economy is not documented and does not respond systematically to monetary measures. While SBP’s policy of keeping negative real interest rates for over three years and pumping money into the system has also resulted in over Rs 8 trillion in circulation, which accounts for almost 20% of the GDP. This further undermines the efficacy of raising interest rates as tool to bring grey cash into the formal economy, adding to inflation.
“At this point in time, tightening policy further is not the answer to inflation or macroeconomic stability. Consumer discretionary demand has already cratered as is evident from high frequency indicators and the cash/undocumented economy does not materially respond to rate hikes,” tweeted Mustafa Pasha, Chief Investment Officer at Lakson Investments Limited.
“Rather focus on continued fiscal adjustments, increasing revenue (by taxing trade, agri, real estate) ending pointless subsidies/tariffs & privatising SOEs. Productivity is the answer, not breaking people to the point where they have to forgo feeding their families,” he added.
Higher interest rates will also make debt servicing an even bigger challenge for the government, as interest expenses have surged significantly. According to the fiscal operations data released for the first eight months of the current fiscal year, Pakistan's interest expenses have surged significantly to Rs 3.18 trillion, which accounts for 81% of the annual debt servicing budget. Further, as per the government’s expectation debt servicing costs may reach nearly Rs 5.2 trillion this fiscal year, which is more than half of the total budget.
However, it looks like the SBP has to resort to hiking the policy to send a strong signal to the market and to satisfy the IMF.
As per a recent editorial published by the Business Recorder, “Any increase in rates to exacerbate the problem would increase the chances of domestic debt restructuring, which could be a nightmare. Thus, higher increase repercussions could surpass benefits. But it’s necessary to send a strong signal across. That is why the doctor’s prescription is to go with the market’s expectation of 1-2 percent increase. And that is perhaps what satisfies the IMF as well.”