Inflation will start slowing down in the second half of fiscal year 2020, anticipated State Bank of Pakistan Governor Reza Baqir.
He announcing a 1% hike in the central bank’s monetary policy rate.
The SBP governor said the new interest rate has already incorporated any increase in the inflation rate over the next two to three months, which may result from recent policy measures as announced in the budget: higher duties on certain commodities as well as an increase in electricity and gas prices.
The central bank has also revised its inflation forecast for the year ending June 30, 2020 and expects the inflation rate to range between 11% and 12%, which is the main reason for raising the interest rate.
Controlling inflation and ensuring economic stability are two of the SBP’s core functions. To achieve these goals, the central bank uses, among other tools, its policy rate.
To contain inflation, the SBP started increasing interest rates in September, 2018 and raised the policy rate by 5.75% to 13.25%, its highest level in the last seven years.
A higher interest rate helped slow down spending towards the end of June, 2019, but core inflation – prices of goods and services excluding food and energy – continued to climb because of an increase in dollar rates and electricity prices, the SBP said. This is also reflected in the data released by the Pakistan Bureau of Statistics as inflation over the same period increased from 5.1% (as in September, 2018) to a five-year high of 9.4% (in March, 2019) before falling back to 8.9% in June. The actual inflation exceeded the central bank’s forecast, which explains today’s monetary policy decision. However, the SBP expects things to change next year.
“We expect a significant reduction in the inflation rate in the first half [July 2020-June 2021] of the next fiscal year as the one-off effect of some of the causes of the recent rise in inflation diminishes,” Baqir said.
The SBP governor said any adjustments that were needed to fix economic imbalances of the preceding year have already taken place and they will consider softening the interest rate policy (maintain or reduce the rate) in future if there is no unanticipated inflation.
Job market to remain tight for a year
The SBP governor expects inflation to slow down in 2020, but the central bank’s forecast for economic growth remains bleak at 3.3%. According to experts, for a country like Pakistan, this growth rate is equal to a recession (negative growth).
Experts say we have been trapped in this cycle of fast economic growth followed by a contraction every few years. This is because our growth is led by imports, which become unsustainable beyond a certain point because our exports do not increase proportionately. This leads the central bank to increase interest rates to slow down the economic growth, which is exactly what the SBP has been doing for the last few months.
The SBP’s policy rate affects every interest rate in the market. A hike in the SBP’s rate means commercial banks will also increase their interest rates, making borrowing more expensive for private businesses and the government, which rely on bank loans to finance new projects. Expensive loans means businesses may put a stop to new investment (other than necessary ones) and the government will borrow less and do fewer projects, which will translate to a slowdown in job creation. These policies affect large scale manufacturing (like factories) and economic activity (business expansion) slows down because the focus remains on economic stability.
According to SBP, it will take a while before the economy is out of this high-inflation, low-growth phase.
“While current high frequency indicators point to a decrease in economic activity, this is expected to turn around in the course of the year,” Baqir said. Explaining, the central bank said the IMF programme [and economic reforms required under it] will help improve market sentiments. A rebound in the agriculture sector and the gradual impact of government incentives for export-oriented industries will also help in an economic turnaround, it said.