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Pakistan holds rate, begins to look to positive real rates

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      Pakistan’s central bank kept its key interest rate steady for the third time but said the domestic economic recovery had gained further traction and while its rate will remain unchanged “in the near term” it is starting to look toward reaching “mildly positive real interest rates” as the economic recovery becomes more durable and the economy returns to full capacity.
     The State Bank of Pakistan (SBP) left its monetary policy rate at 7.0 percent, unchanged since it was last cut in June 2020. 
     ”Most economic activity data and indicators of consumer and business sentiment have show continued improvement,” SBP said, adding there were now upside risks to its current forecast for growth in fiscal 2021, which began July 1 last year.
      As other central banks, SBP began easing its monetary policy stance sharply in March last year in response to the COVID-19 pandemic and cut it 5 times by a total 625 basis points from March to June.
     Prior to the COVID-19 crises, SBP had been on a tightening path, raising the rate 7 times and by a total of 725 basis points from May 2018 to July 2019.
     ”With the inflation outlook relatively benign aside from the possibility of temporary supply-side shocks, the MPC felt that the existing accommodative stance of monetary policy remained appropriate to support the nascent recovery while keeping inflation expectations well-anchored and maintaining financial stability,” SBP said.
     After contracting sharply from March to June last year, Pakistan’s large-scale manufacturing sector returned to expansion in July and SBP said this recovery had strengthened in recent months, with LSM output up 7.4 percent year-on-year in October and 14.5 percent in November.
     So far in the current fiscal year, LSM has grown an annual 7.4 percent compared with a contraction of 5.3 percent in the same period last year. However, the level of manufacturing activity is still below average levels seen in FY19, pointing to continued spare capacity in the economy.
     Pakistan’s inflation rate eased to 8.0 percent in December from 8.35 percent in November and SBP confirmed it still expects inflation to fall within its expected range of 7-9 percent for FY21 and trend toward its 5-7 percent target range over the medium term.
      Although utility tariff increases may cause an uptick in inflation, SBP said this was likely transient given the excess capacity in the economy and well-anchored inflation expectations.
      But amid the favorable outlook, the central bank stressed the trajectory of COVID-19 is difficult to predict given the still-elevated global cases, the emergence of new strains and uncertainties about the roll-out of vaccines worldwide.
      “In light of such Covid-related uncertainties, the MPC considered its appropriate to provide some forward guidance on monetary policy to facilitate policy predictability and decisions-making by economic agents,” the bank’s monetary policy committee said.
      Most major central banks, such as the U.S. Federal Reserve and the Bank of Japan, use forward guidance to signal the expected path of interest rates to help guide the financial decisions by businesses, households and financial markets. 
      Forward guidance was first used during the Global Financial Crises to calm financial markets and investors and has increasingly been adopted by central banks worldwide as part of their tool kit.
      It appears to be the first time Pakistan’s central bank has adopted forward guidance.
     ”In the absence of unforeseen developments, the MPC expects monetary policy settings to remain unchanged in the near term. As the recovery becomes more durable and the economy returns to full capacity, the MPC expects any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates,” SBP said.
     The State Bank of Pakistan issued the following statement:
     
   

1. At its meeting on 22nd January 2021, the Monetary Policy Committee (MPC) decided to maintain the policy rate at 7 percent. The MPC noted that since the last meeting in November, the domestic recovery has gained some further traction. Most economic activity data and indicators of consumer and business sentiment have shown continued improvement. As a result, there are upside risks to the current growth projection of slightly above 2 percent in FY21. On the inflation front, recent out-turns are also encouraging, suggesting a waning of supply-side price pressures from food and still-benign core inflation. While utility tariff increases may cause an uptick in inflation, this is likely to be transient given excess capacity in the economy and well- anchored inflation expectations. As a result, inflation is still expected to fall within the previously announced range of 7-9 percent for FY21 and trend toward the 5-7 percent target range over the medium-term. With the inflation outlook relatively benign aside from the possibility of temporary supply-side shocks, the MPC felt that the existing accommodative stance of monetary policy remained appropriate to support the nascent recovery while keeping inflation expectations well-anchored and maintaining financial stability.

2. While noting these favorable growth and inflation developments ,the MPC also stressed that considerable uncertainty remains around the outlook. The trajectory of the Covid pandemic is difficult to predict, given still-elevated global cases, the emergence of new strains, and lingering uncertainties about the roll-out of vaccines worldwide. Such external shocks could slow the recovery. In light of such Covid-related uncertainties, the MPC considered it appropriate to provide some forward guidance on monetary policy to facilitate policy predictability and decision-making by economic agents. In the absence of unforeseen developments, the MPC expects monetary policy settings to remain unchanged in the near term. As the recovery becomes more durable and the economy returns to full capacity, the MPC expects any adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates.

3. 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

4. The economic recovery underway since July has strengthened in recent months. Large-scale manufacturing (LSM) grew by 7.4 percent (y/y) in October and 14.5 percent (y/y) in November. The manufacturing recovery is also becoming more broad-based, with 12 out of 15 subsectors registering positive growth in November and employment beginning to recover. So far this fiscal year, LSM has grown by 7.4 percent (y/y), against a contraction of 5.3 percent during the same period last year. Nevertheless, the level of manufacturing activity generally remained below average levels in FY19, pointing to continued spare capacity in the economy. On the demand side, cement sales remain strong on the back of rising construction activity, POL sales are at two-year highs, and automobile sales are also rising in both urban (motorcars) and rural (tractors) markets. In agriculture, cotton output is likely to decline more than expected based on latest production estimates. However, this is likely to be offset by improved growth in other major crops and higher wheat production due to the rise in support prices along with announced subsidies on fertilizers and pesticides for Rabi crops. While social distancing is still affecting some service sectors, wholesale, retail trade and transportation are expected to benefit from improvements in construction and manufacturing activity.

External sector

5. Following five consecutive months of surpluses ,the current account registered a deficit of $662million in December. While remittances and exports continued to grow steadily, the trade deficit rose due to a rise in imports of machinery and industrial raw material, in line with the pick-up in economic activity. At the same time, wheat and sugar imports also rose to close demand and supply gaps in the domestic market. Nevertheless, the current account remained in surplus during the first half of FY21, at $1.1 billion compared to a deficit of over $2 billion during the same period last year. This improvement has been mainly driven by workers’ remittances, which have remained above $2 billion every month during the current fiscal year due in part to travel restrictions and supportive policy measures taken by the government and SBP that have increased the use of formal channels. Further, the pick-up in workers proceeding abroad in December bodes well for future prospects. Encouragingly, exports have also recovered to their pre-COVID monthly level of around $2 billion since September, with a broad-based recovery in export volumes recorded in almost all categories in December. Persistent improvement in the current account position and improving sentiment led to a mild appreciation in the PKR since the last MPC meeting and further strengthened external buffers. SBP’s foreign exchange reserves have risen to $13 billion, their highest level since December 2017. Based upon the data available so far, the outlook for the external sector has improved further and the current account deficit for FY21 is now projected to remain below 1 percent of GDP.

Fiscal sector

6. Fiscal developments have been largely in line with this year’s budget and the government has continued to adhere to its commitment of no fresh borrowing from the SBP. Despite higher interest payments and Covid-related spending, healthy growth in revenues has contained the fiscal deficit during the fiscal year so far. Provisional estimates suggest that net FBR revenue grew by 3.0 and 8.3 percent (y/y) in November and December, respectively. Driven by a rebound in direct taxes and the sales tax, FBR revenue during H1-FY21 has grown by 5 percent (y/y) to come in close to the targeted level. Despite higher non-interest current expenditures, the primary balance posted a surplus of 0.5 percent of GDP during July-November, 0.2 percentage points better than the same period last year.

Monetary and inflation outlook

7. The MPC noted that financial conditions remain appropriately accommodative at this early stage of the recovery, with the real policy rate in slightly negative territory on a forward-looking basis. Private sector credit has seen an encouraging uptick since the last MPC meeting, driven by a continued rise in consumer and fixed investment loans on the back of SBP’s refinance facilities. As demand recovers and inventories fall in some sectors, working capital loans have also picked up for the first time since the onset of the Covid pandemic, although their level remains lower than last year.

8. Inflation pressures have eased since the last MPC, despite an upward adjustment in fuel prices. After remaining close to 9 percent in the preceding two months, headline inflation fell to 8.3 percent in November and further to 8 percent in December, the lowest rate since June 2019. This decline is mainly attributable to easing food inflation. Owing to conducive weather and various measures taken by the government to address supply-side issues, the price of perishables, wheat, pulses and rice has declined. Moreover, core inflation has continued to remain relatively soft since the beginning of FY21, in line with the presence of spare capacity in the economy. Inflation expectations of both businesses and consumers remain well-anchored and have declined in recent months. As a result, at this stage of the recovery, any further supply-side shocks from food or utility tariffs are unlikely to have a lasting inflationary impact through second-round effects.”

    www.CentralBankNews.info




Source: http://www.centralbanknews.info/2021/01/pakistan-holds-rate-begins-to-look-to.html


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