The tightening continues – BR Research


The key rate is up 125 basis points to round it up to 15%. It was not an easy decision. The SBP expects inflation to average 18-20% for FY23 (next 12 months). Based on this assumption, SBP maintains negative real rates. Most of the SBP decision and communication is in accordance with the prescribed policy in this space with degrees of separation.

And SBP’s inflation forecast carries risks, such as global commodity prices, domestic fiscal stance and the exchange rate. Seeing these risks, SBP gives no firm forward guidance, saying that going forward, MPC will be data driven. This means that if any of the three factors go south, expect further tightening.

And these variables are related. For example, if global commodity prices rise, it would be difficult for the government to pass on the impact, and without it, the currency could go haywire. This leads to inflation – through higher world prices and a depreciation of the PKR. To counter them, monetary tightening becomes inevitable.

Second, global tightening (in advanced economies) puts pressure on emerging economies’ currencies. Depreciation to bring inflation and to counter falling currencies (which is inflationary in nature), the SBP must raise interest rates further. This risk can be managed if international commodity prices fall due to the global tightening. Then there is world politics (the war in Ukraine has a part to play).

The third variable is domestic political risk. Ever since the vote of no confidence (VoNC) was about to be tabled, successive governments began to make economically unwise decisions. It all started with no change in oil prices by the PTI government in March and then was taken over by the incumbents. Even today, after making tough decisions, perhaps the SBP still values ​​the fact that short-term political constraints can jeopardize economic sustainability, as the national political landscape is not yet stable. .

The thing is, there are too many ifs and buts in the equation. There are many national and international economic and political factors at play, all of which have implications for domestic politics. And the most important factor is the continuation of the IMF program. As without it, the SBP’s foreign exchange reserves would fall to dangerously low levels, which could trigger a run on money and hyperinflation. To counter this, SBP should be extra vigilant. This may be why SBP put its weight on the crunch this time and refrained from giving firm guidance.

So SBP faces another dilemma. It’s the credibility of monetary policy. For a few reviews, SBP has been following the market. Market rates remained (almost constantly) above the policy rate and the SBP policy rate continued to track market rates. SBP does not want this gap to continue. And again, SBP matched market rates by reaching market rate levels.

This is not an easy task for SBP. Market liquidity to fund government borrowing relies primarily on SBP injections through open market operations (OMOs). This toll is now approaching Rs5 trillion. The other avenues of funding have dried up. Banks are the lenders. And banks are worried about mark-to-mark losses on government paper as interest rates rise. Their interest is limited to three-month paper and financing by injection of OMO spread over the OMO. The shortening of the debt maturity profile is another headache.

The situation is still fluid. However, fiscal and monetary policy responses are currently moving in the right direction. Given that the IMF is back, after the government has made the remaining adjustments and agreed to structural reforms, and global commodity prices have not risen further, there should be no reason for another hike. rates.

The SBP’s demand-tightening ability diminishes as rates gradually rise to such high rates. That said, SBP is still worried about demand, which has stopped growing; but did not start to decline and remain at high levels. The SBP may have to wait and see the impact of fiscal contraction policies enacted in June to be reflected in the numbers in the coming months.

It therefore makes sense to live with negative real rates this year. However, some may argue that savers are at a disadvantage because they are unable to hedge inflation by putting money into fixed income instruments. It’s a compromise that could be better for the economy as a whole.

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