IMF takes recourse to SBP to contain inflation

Exterior of the State Bank of Pakistan building in Karachi.  - AFP/File
Exterior of the State Bank of Pakistan building in Karachi. – AFP/File
  • The IMF report states that monetary policy has slowed down.
  • “Monetary policy needs to remain tight, proactive, data-driven.”
  • It states that the independence of the SBP should be strengthened, protected.

Islamabad: The International Monetary Fund (IMF) has strongly criticized the State Bank of Pakistan (SBP) for failing to respond to the build-up of inflationary pressures since 2020 by tightening monetary policy in a timely manner.

“The monetary policy fell behind the curve, as five-decade high inflation and de-anchored expectations created price pressures,” the IMF said in its staff report following the approval of a $3 billion standby arrangement program for Pakistan.

“Several interruptions in the policy rate tightening cycle and a dramatic increase in the size of SBP’s open market operations (OMOs) to keep the policy rate within range resulted in a loosening of the monetary policy stance, at a time when inflation was already on the rise.”

The IMF report said inflationary expectations turned unfavourable, with more than 90% of consumers in the SBP’s May survey expecting higher prices over the next six months.

The Monetary Policy Committee raised the policy rate by 100 bps on 26 June, bringing it to 22%, while at the same time, the interest rates on its two main refinance schemes (EFS and LTFF) were increased by a similar amount, keeping the gap with the policy rate at three percentage points.

“Monetary policy needs to remain tight, proactive and data-driven. The recent policy rate hike is welcome, but the tightening cycle should continue if needed to moderate inflation and facilitate external rebalancing,” the IMF said, indicating the need for further policy rate hikes in the coming months.

In the short term, the forward-looking real policy rate should return to positive territory to reinvigorate expectations and achieve the SBP’s inflation objective in the medium term, the IMF said.

Implementation of the plan for phasing out of refinance schemes will strengthen the monetary policy grip and bring transparency in these schemes. It added that the important thing is that the independence of the SBP should be strengthened and protected.

A tight monetary policy stance is important to moderate inflation, re-establish expectations and support external sector rebalancing through the exchange rate.

While the latest policy move from the SBP is a welcome move, the IMF said officials remain generally optimistic about a rapid easing of inflation pressures and a return to their 5-7% inflation target range by the end of fiscal 2025.

The staff emphasized that the SBP will need to continue its tightening cycle to reinvigorate expectations, as inflationary pressures are expected to persist in the year ahead, with exchange rate correction continuing to impact the economy.

The SBP agreed to maintain a tighter monetary policy stance – higher rates and prudent use of liquidity injections – as needed, given incoming data, to achieve real positive interest rates on a forward-looking basis, and to keep inflation and inflation expectations clearly downwards.

At the same time, it will be important to improve monetary transmission and monetary operations framework. SBP is also committed not to introduce fresh refinance schemes and to keep the outstanding debt of the refinance facilities below their current limits.

The IMF said that after nearly two years of persistently rising headline inflation, headline inflation is expected to ease from June onwards, driven by a base effect of a rise in fuel and electricity prices last year and a lower contribution from food items.

But price pressures are expected to remain elevated, including as a result of much delayed monetary tightening; Thus, average headline inflation is expected to remain above 25% in FY2024, with only end-period inflation falling below 20% in FY24.

Similarly, core inflation is set to ease very slowly in FY24 due to elevated inflation expectations and the necessary tightening of policies running with a gap.

The decline in headline inflation will continue in FY2015, with EOP inflation only falling to single digits in mid-FY26.

Over the past six months, inflation has continued to rise, partly due to rising food prices and depreciation, but also due to the above deficit exerting pressure on prices.

Price movements widened sharply, with core inflation reaching 22.8% (YoY) in May 2023 and headline inflation reaching 38%, a record high, particularly hurting low-income earners.

Despite mounting pressures, the SBP’s actions lacked clarity, as it kept its policy rate unchanged at MPC meetings in August, October and early June, expecting that price increases had peaked and would subside, but raised rates in late November, March, April and June.

The previous hikes brought the policy rates cumulatively to 22%, an increase of 825 bps (basis points) since the beginning of FY23.

Originally published in news

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