Karachi December 10 2021: Pakistan’s economy needs a tighter monetary policy, and we expect the central bank to deliver another 150 basis point interest rate hike at its Dec. 14 meeting says Ankur Shukia Bloomberg Economist.
Even with that, it probably won’t be done withdrawing stimulus, as it moves to counter a widening current account deficit and rising inflation.
A 150 bp hike — the same magnitude as its increase in November — would lift the policy rate to 10.25%, front-loading some tightening in the race against the growing imbalances.
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The tighter policy could temper consumer price pressures and tamp down on import demand that drove the trade deficit to a record in November.
If, as we expect, the trade deficit starts to narrow in coming months, State Bank of Pakistan could slow the pace of rate increases in 2022. Even so, we expect the policy rate to reach 12.75% by next June.
Elevated global commodity prices and a strong recovery in the economy have kept the import bill elevated so far this fiscal year, which started July 2021. This has led to a deterioration in the current account balance. The account balance swung to a deficit of $5.1 billion in the July-October period from a surplus of $1.3 billion in the same period last year.
November data show a further $1 billion widening in the trade deficit to an all-time high of $5 billion as imports soared 82% from a year earlier. This spells a further widening in the current account deficit this quarter.
The weakening external account has eaten into Pakistan’s foreign exchange reserves. The stockpile shrank by $4.1 billion in the three months through November — the sharpest drawdown since July 2019. The currency fell about 7% against the dollar over the same period.
Looking ahead, we see reason for the trade balance to improve in 2022, with several factors likely to reduce imports:
The central bank is attempting to moderate demand for imports through rate hikes and other means, such as prohibiting financing for imported vehicles.
Forward prices for commodities that make up a significant portion of Pakistan’s imports — crude oil, palm oil, and steel — point to price decreases through June 2022 from current levels. If that pans out, the import bill should come down in the second half of fiscal 2022.
Inflation surged more than expected to 11.5% in November from 9.2% in October, mainly due to higher fuel prices and hikes in electricity tariffs implemented in November.
Fiscal conditions recently agreed with the IMF to secure a bailout package mean the government will raise taxes on fuel and food items and raise electricity tariffs further in 2022. These tax increases should directly push up prices in 2022.
We expect inflation to peak in the January-March quarter before slowing gradually. A tighter monetary policy should weaken demand-pull price pressures. A possible reversal in currency weakness on an improvement in the external balances and softening in global commodity prices should also exert downward pressure on inflation. That said, inflation is still likely to remain above 10.5% for the rest of fiscal 2022.
