By Gibran Naiyyar Peshimam and Asif Shahzad
KARACHI, Pakistan (Reuters) – Pakistan’s central bank on Monday raised its key interest rate by 100 basis points to 17% in a bid to rein in persistently high inflation, and it said achieving price stability was key to attaining sustainable economic growth in the future.
The increase, which matched the majority forecast of the economists and market watchers surveyed by Reuters, takes Pakistan’s benchmark rate to its highest level since October 1997.
Policymakers are facing tough times in the $350 billion economy, with high inflation and a sharp fall in reserves, which at $4.6 billion, barely enough to cover three weeks’ worth of imports.
“The committee found that the 1% increase was inevitable,” the bank’s governor Jameel Ahmad told a news conference on Monday.
In November, the State Bank of Pakistan’s Monetary Policy Committee unexpectedly pushed up its key rate by 100 bps, meaning it has now raised it by a total of 725 bps since January 2022.
The country – struggling after last year’s devastating nationwide floods – posted a 24.5% annual inflation rate in January.
The MPC said anchoring inflation expectations was vital to achieve its midterm inflation target of 5% to 7% by December 2024 and requires coordinated monetary and fiscal policy efforts, the bank said in a statement after the news conference.
“The committee noted that inflationary pressures are persisting and continue to be broad-based. If these remain unchecked, they could feed into higher inflation expectations over a longer than-anticipated period,” the bank said.
“The MPC stressed that it is critical to anchor inflation expectations and achieve the objective of price stability to support sustainable growth in the future.”
Although some moderation was seen in inflation in November and December, it remains high and core inflation has been on a rising trend for the last 10 months, the central bank added.
“The SBP had failed to anticipate the sharp rise in inflation and is now playing catch up to satisfy the International Monetary Fund’s concerns,” said Yousuf Nazar, an economist and former strategist at Citigroup.
“More importantly the SBP is continuing with the policy of artificially maintaining an unrealistic exchange rate which has led the remittances to fall by an average of $500 million per month since July,” he added.
The lack of fresh financial inflows and ongoing debt repayments have led to a steady drawdown in official reserves, the central bank said.
The MPC also noted that the country’s current fiscal stance is inconsistent with monetary tightening.
“Thus, given the evolving macroeconomic challenges, it is important for fiscal policy to achieve the planned consolidation in order to help contain inflation and pave the way for sustainable growth,” it wrote.
The bank said the fiscal deficit has widened to 1.5% of economic output in the first four months of the fiscal year that began last July from 0.9% in the same period a year earlier.
With the foreign exchange crunch, the South Asian economy’s managers have been focusing on reducing current account deficit, mainly by reducing imports.
“The current account deficit narrowed by around 60 percent to $3.7 billion in H1-FY23,” the central bank said. “This substantial reduction was due to a sharp contraction in imports, reflecting the impact of policy tightening and administrative measures.”
The bank said developments suggested the downside risks to its baseline growth outlook for this year had increased.
Pakistan is struggling to quell default fears in domestic and international markets, with a $1.1 billion IMF bailout tranche stuck due to differences over a programme review that should have been completed in November.
Other multilateral and bilateral financing avenues are linked to the IMF programme, meaning the South Asian nation of 220 million people will be hard-pressed to meet its external financing needs of over $30 billion up until June 2023, including debt repayments and energy imports.
The finance ministry is holding technical level talks to resume the latest review of its IMF programme, the governor said.
(Reporting by Asif Shahzad in Islamabad; Writing by Swati Bhat; Editing by Sudipto Ganguly and Hugh Lawson)