State Bank of Pakistan declared the monetary policy on July 15, 2018. As per SBP, Pakistan’s economy has achieved a thirteen-year highest growth rate of 5.8 percent in FY18 and the average CPI inflation also remained well below the 6.0 percent target. However, the challenges have further risen. Firstly, In May 2018, SBP anticipated the fiscal deficit of 5.5 percent; which has actually risen to 6.8 percent. The current account deficit is PKR 16 billion during May – Jul 18, which was PKR 11.1 billion in matching period last year. This proves that aggregate demand is higher than expectations. Secondly, although the year-on-year Jun inflation is at 5.2 percent. However, the average inflation for FY 19 is expected to cross 6.0 percent annual target. Thirdly, though both exports and workers’ remittances remained better, increase size of imports continues to pressurize FX reserves.

Real economic activity repeated the its strong performance of FY 17, but by the end of FY 18 due to some challenges sluggish growth is expected. In agriculture sector, production in FY 19 is expected to remain below the target due to water shortage. Manufacturing sector is also depicting a mix picture due to high-base effect. Construction sector is expected to perform at par. Considering the above factors, SBP projects GDP growth of around 5.5 percent as compared to annual target of 6.2 percent for the FY 19. CPI inflation is expected to remain at 6.0 – 7.0 percent for FY 19, depending on the following factors: a) higher fiscal deficit b) food inflation going back to normal behavior c) unfavorable trend in international oil prices d) lagged pass-through of rupee devaluation and e) high survey-based measures of inflation expectations captured by July 2018.

Monetary expansions in FY18 are driven by government borrowings for budgetary support and healthy growth in credit to the private sector. In FY 19, private sector credit is predicted to grow at the rate of around 13 percent, due to rise in need of working capital for production and rising exports. The current account deficit declined to $ 16.0 billion during first eleven months of FY 18, which is 1.4 times over the same period last year. The encouraging impact of increase in exports and workers’ remittances was offset by increase in imports. Strong demand for productive imports like metal, machinery and petroleum, for supporting the economic activity along with hike in international prices have increased the current account deficit. As a result, SBP’s liquid FX reserves reduced by US$ 6.7 billion and reached at the level of US$ 9.5 billion as of July 06, 2018.

Keeping in view the above factors, the Monetary Policy committee concluded that following factors are contributing to evolving economic challenges: (i) the multiplier-effect of a strong fiscal expansion during the second half of FY18 is likely to offset the impact of monetary tightening in the recent months on domestic demand; (ii) higher international oil prices have sustained to expand the import bill (iii) rising inflation forecasts and the resultant fall in real interest rates; and (iv) a notable reduction in PKR and US interest rate disparity.

In order to control aggregate demand and ensure near-term steadiness, the committee has decided to increase policy rate by 100 bps to 7.5 percent effective from 16 July, 2018.

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