The policy rate is the benchmark interest rate that helps determine the general cost of borrowing in the economy. The SBP uses this monetary policy tool to achieve price stability and economic growth targets.
In a press statement, the SBP said that the declining momentum in inflation is expected to reverse going forward. Measured by the Consumer Price Index (CPI), inflation has averaged 1.7% in Jul-Oct, which is notably lower than the CPI of 7.1% recorded in the comparable period of 2014-15.
A majority of analysts had expected the SBP to maintain the policy rate at 6%. As many as nine out of the 10 research houses polled on November 19 had expected the status quo to prevail in the SBP’s monetary policy announcement.
Currently, the discount (or ceiling) rate is 6.5% while the newly introduced target rate stands at 6%. The SBP reduced the target rate from 6.5% to 6% in its last announcement in September after bringing it down by 300 basis points in 2014-15.
Central banks tend to either maintain or increase the benchmark interest rate at a time when inflation is expected to rise. Although the recent decline in inflation is ‘broad-based’, the absence of the high-base effect from November onwards is likely to push up the CPI in coming months, analysts say.
Another reason for keeping the policy rate unchanged appears to be the rupee-dollar exchange rate, a topic that seems close to Finance Minister Ishaq Dar’s heart. Further slashing the benchmark interest rate would quicken the devaluation of the rupee, which is already among Asia’s worst performing currencies this quarter, according to Bloomberg.
The rupee has lost 3.6% since the beginning of fiscal year (FY) 2015-16. With the likely increase of the interest rates by the US Federal Reserve next month, the dollar is already expected to gain strength while devaluing the rupee.
Despite a year-on-year decline of 10.6% in exports, Pakistan has managed to limit its current account deficit to $532 million in Jul-Oct, thanks mainly to declining global oil prices, remittances and inflows under the Coalition Support Fund (CSF).
The SBP says continued flows of external resources will be required to maintain the stable balance of payments position. “Furthermore, the realisation of investment inflows stemming from the China-Pakistan Economic Corridor (CPEC) will indeed strengthen the external sector outlook over the medium to long term,” it said.
Despite an all-time low benchmark interest rate, private-sector credit off-take has been dismal so far. The outstanding position of loans extended to private-sector businesses went up only 5.1% year on year at the end of September. However, the SBP believes the current credit cycle is now entering the “uptake phase”. With improving large-scale manufacturing growth, borrowing on account of both working capital and fixed investment is likely to increase, the central bank said.
Topline Securities CEO Mohammed Sohail said credit growth in 2015 is “not impressive at all” despite low interest rates. However, he shares the SBP’s optimism with regard to the private-sector credit uptake in coming months, noting that the financial close of major projects is expected in 2016. Karachi Chamber of Commerce and Industry President Younus M Bashir said interest rates in Pakistan are considerably higher than those in comparable countries.
“But decreasing interest rates alone will not increase the industrial output,” he said while referring to supply-side constraints, like energy shortages that hinder private-sector credit growth.