A third wave of coronavirus infections creates uncertainty
The Monetary Policy Committee of the central bank has decided to maintain the policy or interest rate at 7% as a third wave of coronavirus infections poses a threat to the economy.
“In reaching its decision on the policy rate, the MPC also took note of the uncertainty around the inflation and growth outlook,” the central bank said in a statement.
“On the growth front, the MPC noted that despite recent momentum, risks remain due to the emergence of a third, more virulent wave of Covid in Pakistan just as the vaccine roll-out is beginning.”
The MPC noted 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%, growth in fiscal year 2021 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,” the statement said.
“Recent inflation 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.”
The statement said the recent increase in inflation is primarily due to supply-side factors.
What role does the policy rate play in Pakistan’s economy?
Controlling inflation and ensuring economic stability are two of the central bank’s core functions. To achieve these goals, the SBP uses, the policy rate among other tools. This is the rate at which commercial banks borrow money using the central bank’s discount window.
The policy rate, which is 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.
On the other hand, a lower interest rate encourages people and businesses to borrow more, which in turn increases consumption on the national scale. Since the overall demand is high, it makes the prices of goods rise, thus inflation increases.
The role of the central bank is to maintain a level of interest rates that keeps inflation in check while also not reducing the economic activity.