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  • Interest rate hiked to 6.5pc, risks mounting

    Interest rate hiked to 6.5pc, risks mounting Interest rate hiked to 6.5pc, risks mounting

    The State Bank of Pakistan (SBP) increased its policy rate by 50 basis points to 6.5 per cent on Friday saying that balance of risks to the sustainability of growth has shifted while current account deficits and fiscal deficits have exceeded the earlier estimates.

    The central bank announced the Monetary Policy Statement with details to justify second increase in the interest rate during the current fiscal year. In January, the key rate was raised by 25 basis points to 6pc after keeping it steady for 20 months.

    The SBP said the balance of risks to the sustainability of the healthy growth with low inflation has shifted due to deteriorating balance of payments and this was due to high petroleum prices and limited financial inflows.

    Another reason for this imbalance was the revised fiscal deficit which was 5.5pc GDP as compared to 4.1 per cent for FY18.

    “These twin deficits -- depicting the elevated aggregate demand in the country -- are adversely affecting the near-term macroeconomic stability,” said the SBP.

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    The SBP believes that the economic growth is provisionally estimated to achieve a 13-year high level of 5.8pc for FY18. Concurrently, headline inflation remains moderate and is expected to stay well below the annual target of 6pc.

    The CPI inflation remained 3.8pc during the first 10 months of this fiscal year while the food inflation clocked in 1.8pc during this period.

    “Contrary to this, average of year-on-year NFNE (non-food non-energy) core inflation during the last two months has risen to 6.4pc, which reflects the building up of inflationary pressures in the economy,” said the SBP.

    The average inflation for FY18 is projected to remain within SBP’s model-based range of 3.5-4.5pc whereas the average FY19 inflation is estimated to be marginally above the annual target of 6pc, said the SBP.

    The SBP said turning to the supply side, the real sector has posted a broad-based healthy growth in FY18.

    “Helped by strong growth in major crops and a modest increase in livestock, agriculture sector has not only recorded a notable improvement over the last year but also surpassed the annual growth target of 3.5pc per cent,” the central bank noted.

    Meanwhile, industrial sector grew by 5.8pc, primarily because of vibrant construction activity and notable improvement in large-scale manufacturing.

    These gains in the commodity-producing sector along with growing aggregate demand have pushed the growth in services to 6.4pc, said the SBP.

    Keeping in view this strong growth momentum and the upcoming investments in auto and construction allied industries, the government has set the real GDP growth target of 6.2pc for FY19.

    “The assessment of overall macroeconomic picture suggests that this target is ambitious and would critically depend on managing the growing pressures on the external account while ensuring that average inflation is contained close to its target in FY19,” said the SBP.

    On the external front, the current account deficit widened to $14bn during the first 10 months of FY18, which is 1.5 times the level of deficit realised during the same period last year.

    “Despite a strong recovery in exports (year-on-year increase of 13.3pc during July-April period of 2017-18) and a moderate increase in workers’ remittances (a growth of 3.9pc), the growing imports to support higher economic activity and the sharp increase in oil prices have pushed the current account deficit to a higher level,” observed the SBP.

    In the absence of sufficient projected financial flows, a portion of this higher current account deficit was managed by using country’s own resources during FY18. Consequently, the SBP’s liquid foreign exchange reserves saw a net reduction of $5.8bn to $10.3bn as of May 18.

    Reflecting the increasing pressures in the external sector, the rupee has depreciated by 9.3pc against the US dollar till May 24, said the SBP.

    “The near-term sustainability of prevailing higher current account deficit critically depends on the realisation and further mobilisation of financial flows. The need for deep-rooted structural reforms to improve the country’s competitiveness can hardly be overemphasised for medium- to long-term sustainability of balance of payments,” remarked the SBP.