Modest current account deficit is sustainable in EMs: Reza Baqir
The State Bank has decided to keep interest rates unchanged for the next two months to support the economy during the coronavirus pandemic.
In a press conference Tuesday, Governor State Bank Dr Reza Baqir said that the inflation rate has fallen but the coronavirus pandemic is not yet over, therefore, the central bank has decided to keep the policy rate unchanged.
This is what the market has been expecting too.
The State Bank announces monetary policy every two months and interest rate is an important part of it. The next monetary policy will be announced on September 20.
Baqir said that Pakistan’s current account deficit was the lowest in ten years at $1.8 billion or 0.6% of the gross domestic product (GDP).
The current account deficit between 2% to 2.5% is normal for emerging markets such as Pakistan. He pointed out that exports have increased by 13.7%, while remittances have seen a historic high of 25%.
Remittances are expected to increase but the growth may not be as high as it was last year, the governor remarked. Exports are expected to grow too.
Baqir said that Pakistan’s exchange rate (dollar rate) has been market-based for the last two years. This means that the rates are subject to fluctuations by what happens in the international market.
“When the exchange rate stays the same, the current account deficit rises and foreign exchange reserves decrease,” the governor said. “This has happened in the past. But right now, the exchange rates are fluctuating and although there’s a current account deficit, the reserves are rising.”
He said that imports, too, will increase with economic recovery. “Imports in the previous months rose because of machinery, Covid-19 vaccines, and food items.”
The State Bank’s assessment of inflation for the ongoing fiscal year is between 7% and 9%.
In March 2020, the interest rate was at 13.25%. By June 2020, it was reduced to 7% due to the pandemic. The State Bank has not increased interest rates in the last six monetary policies.
Controlling inflation and ensuring economic stability are two of the State Bank’s core functions. To achieve these goals, the central bank uses, among other tools, its policy rate. This is the rate at which commercial banks borrow money from the central bank’s discount window.
The rate, revised every two months, affects every interest rate in the market. In other words, a higher policy rate means commercial banks will charge more, making borrowing more expensive for individuals, businesses, and the government.
Higher interest rates make loans expensive. Businesses, which rely on bank financing, stop new projects, the government cuts spending on development projects, and consumers stop availing auto finance, home loans and even reduce credit card use. In a nutshell, a higher interest rate shrinks economic activity and slows down job creation.