Experts welcome SBP’s monetary policy decision, but piqued over volatile inflation out-turn

By Faraz Saeed
Published in Daily Times on March 22, 2021

Economists and stock market experts have welcomed State Bank of Pakistan’s (SBP) decision to keep the benchmark interest rate unchanged at 7 percent for the fourth consecutive time, while viewing growth as well-anchored, but warned of inflationary pressure which could upend the central bank’s projections.

SBP’s Monetary Policy Committee (MPC) on Friday decided to maintain the policy rate at 7 percent, noting that since the last meeting in January, growth and employment have continued to recover and business sentiment has further improved. While still modest, at around 3 percent, growth in FY21 is now projected to be higher than previously anticipated due to improved prospects for manufacturing and reflecting in part the monetary and fiscal stimulus provided during Covid, State Bank of Pakistan (SBP) said in a statement.

But, the SBP illustrated that on the inflation front, recent out-turns have been volatile, with the lowest reading on headline inflation in more than two years in January 2021 followed by a sharp rise in February. According to SBP estimates, the recent increase in electricity tariffs and sugar and wheat prices accounts for about 1½ percentage points of the 3 percentage point increase in inflation between the January and February out-turns.

The central bank cautioned that a recent increase in electricity prices will continue to manifest in headline numbers in coming months, keeping average inflation in FY21 close to the upper end of the previously announced range of 7-9 percent.

Talking to this scribe, senior economist and Head of Research, Alfalah CLSA Securities Fahad Irfan praised SBP for maintaining the status quo on policy rate, and said the central bank’s decision to act upon its forward guidance, issued in the previous monetary policy, has increased and cemented the trust of businessmen and investors on the bank.

While commenting on the monetary policy settings in the future, Mr Irfan added, that “SBP will take a wait and see approach in Mar-21, and gradually begin raising rates from May-21,” since core inflation has started creeping up, with Urban/rural (trimmed) core inflation increased from 5.7/8.1% in Jan-21 to 7.9/9.2% in Feb-21 respectively. The real interest rate (Policy rate minus national CPI) stood at -170bps in Feb-21, he added.

Joining the ranks of those appreciative of SBP’s monetary policy announcement, senior vice president, BMA capital management Limited, Mr Irfan Saeed welcomed the central bank’s policy decision, and said it will mark an end to the uncertainty in the market, which will attract fresh investors’ interest; primarily in the main board stock i.e Fertilizers, Autos, Steel and Cements.

Mr Saeed said that perhaps, the most exciting news for the market in the MPC announcement is the surge in SBP’s projection of growth in FY21, which MPC stated will hover around 3 percent, higher than previously anticipated “slightly above 2 percent”. Mr Saeed added that since the market has already witnessed a sharp rebound from last week, unchanged policy rate, is likely to accelerate Bull Run in the short run.

But, Mr Saeed cautioned that pressure continues to mount on interest rates as markets remain stubbornly wedded to their expectation of a rate hike in the near future. He said the latest auction of government debt instruments (known as Treasury bills, or T-bills) cut-off yields rose by up to 34 basis points. The yield on three-month T-bills was increased by 34 basis points to 7.59 per cent while for the benchmark six-month papers it was jacked up by 25 basis points to 7.80pc, he explained. Mr Saeed added that the bids pattern showed that the banks were asking for higher returns which forced the government to borrow at slightly higher rates, reflecting the growing pressure of inflation which would force the SBP to increase the interest rate by May FY21.

Mr Saeed’s remarks on SBP’s policy announcement reflect, days of speculation by investors at the Pakistan Stock Exchange (PSX) ahead of monetary policy announcement, when investors continued to offload their stakes over a possibility of increase in the Bank rate.

Meanwhile, noting that central Bank’s policy announcement is consistent and prudent, Senior Economist, Professor of Economics and Director, Graduate Institute of Development Studies, Lahore School of Economics Dr Rashid Amjad, said SBP’s decision to keep the rate unchanged at 7%, despite rise in inflationary pressure, represents its continuous policy of reviving growth.

But, warning about the volatility in the recent out-turns of inflation, Dr Rashid said “if inflation continues at the upper expected range of 7-9 percent or rises further, then there will be no option but to raise the bank rate to keep real interest rates at near the inflation rate, adding that “The real inflationary pressure could come, if the wheat crop is even less than the expected shortfall and imports do not arrive in time.” While advising the government to mitigate inflationary pressure in the near future, Dr Rashid said the “government at the provincial and district level must remain vigilant and ensure no hoarding or breaks in the supply chain”.

The SBP in its statement did shared the Dr. Rashid’s concern, and mentioned that “while prices of perishable food items have moderated since the last MPC, hikes in administered prices, sugar and wheat led to a significant rise in headline inflation in February 2021, arresting the downward trend observed since September 2020.” In terms of the inflation outlook, “this summer’s wage negotiations and any new tax measures in the next year’s budget could add further supply-side shocks. In addition, optimism about a stronger US-led world recovery this year is translating into higher international commodity prices, including both food and oil, which could continue to feed into domestic inflation, ” SBP said.

In view of this concern, it is also pertinent to mention that Sindh’s new wheat crop has already landed in Karachi’s wholesale market with the highest-ever price tag of Rs.5,000 per 100 kg bag, fuelling fears it may trigger price distortions in the country. The sharp hike in wheat rate is due to a massive increase to Rs.2,000 per 40 kg in the wheat procurement price by the Sindh government. Last year, the wheat procurement price in Sindh was fixed at Rs.1,400 per 40kg, which took the per 100kg bag price to Rs.4,100.

From a monetarist point of view, inflation is nothing but a monetary phenomenon and when low interest rates prevail for a few quarters they are bound to increase inflationary pressures later on because the very purpose of lowering interest rates is to encourage people to spend and borrow more. When more money is spent and remains in circulation, productive sectors find it encouraging to boost production. But outputs grow gradually and systematically and not at once. So in the intervening period, prices move up. That is happening now and will continue to happen at least till the end of this fiscal year.

Since, SBP has no magic wand to control inflation at a time when it is already busy ensuring monetary expansion for economic recovery. Thus, this year’s upcoming round of wage negotiations, next year’s budget, and the path of domestic energy prices and international commodity prices, will have important bearing on the future inflation trajectory, therefore it is expected that SBP will ‘gradually’ end its accommodative policy in May21, as it has already emphasized that “any adjustment in the policy rate would be measured and gradual to achieve mildly positive real interest rates”, which stood at negative 170 bps in February.

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