Subject: Money and Commercial Banking

Report on Pakistan’s Monetary Policy 2022

Submit to:
Ma’am Zainab Parveen

Submitted by:
Abdul Wahab Butt (FA21-BEC-003)
Aiza Haq (FA21-BEC-006)
Aleena Rashid (FA21-BEC-007)
Ayaz Ahmed (FA21-BEC-010)
 Monetary Policy of Pakistan 2022

INTRODUCTION:
Monetary Policy is a macroeconomic policy of using monetary variables to
influence aggregate demand. Typically, monetary policy is carried out by the
central bank but the level of autonomy of the central bank from the ruling
government tends to vary from state to state.

There are two types of monetary policies:

i- Contractionary/Deflationary
ii- Expansionary/Reflationary.

A monetary policy enacted to reduce aggregate demand is termed as

contractionary/deflationary. However, monetary policy that raises aggregate
demand is referred to as expansionary/reflationary.

Monetary variables:
It consists of (I) interest rates, (ii) money supply and (iii) exchange rate.

I. Interest rate is the additional amount to be paid to the lender by the

burrower over the top of the principal amount. Interest rates can say to
be the reward for saving and price for burrowing funds. Regarding
monetary policy, the interest rate referred to there is policy rate. The
Bank rate is the interest rate offered to commercial banks from the
central banks for burrowing cash. The reward and cost of interest rate
serves similarly to the Marshallian demand and supply curve. Except in
place of price and quantity of goods, we have interest rate (cost and
reward for provision of funds) and quantity of money. Although it should
be noted that the desired effects of altering the interest rates have a
time lag of 18 months potentially.
In figure 1 you can see a typical demand curve (downward sloping) and an
inelastic supply curve, a consequence of the complete control of money supply
in the hands of the central bank. As it can be observed the demand for
quantity of cash falters as interest rates rise and vice versa.

Figure 1

II. Money supply is the total amount of money in an economy. The central
bank has 4 primary tools at their disposal for influencing money supply:
reserve requirement, open market operations, the Bank rate, and
interest on reserves. Reserve requirement is the minimum levels of
money banks must hold. Open Market Operations is the selling and
acquirement of government bonds for the purposes of changing money
supply. Interest on reserves is the interest paid by commercial banks for
holding reserves beyond a certain limit, in the hopes of goading
commercial banks to lend more.

III. Exchange Rate is the price of one currency in terms of another currency.
Monetary policy here can be what type of exchange rate system to
employ in the economy. A floating exchange rate is the one that
operates on the free market forces of demand and supply, while a fixed
 exchange rate sets a specific value for the currency to be maintained by
the bank. Managed float is the combination of both systems, where
instead of having a singular set value the system has upper and lower
limits. If the value of the currency stays between those limits the central
bank will not interfere.

Why Aggregate Demand?

Monetary policy influence aggregate demand not for its own sake but rather to
influence GDP, unemployment, and inflation. Most administrations seek a
rising sustainable GDP rate, low unemployment rate and low stable inflation
rate.

Types of Monetary Policy:

I. Contractionary/Deflationary monetary policy

This can be achieved by a rise in interest rates and/or foreign exchange rates,
and a decline money supply.

A government reducing money supply in an economy will lead to an increase in

the value (interest rate) of available funds, thus making burrowing more costly.
This in turn reduces both total investment and consumption within an
economy, as firms and consumers to reduce their economic activities due to
the lack of funds. This is marked by fall in aggregate demand and reducing the
GDP and employment. However, this also reduces the general price level
within an economy.
Figure 2

Appreciation/revaluation of currency causes exports of an economy to

become more expensive for other nations and reduces the prices of imports.
This causes downturn in the GDP as international demand falls due to increase
in prices. However, in certain cases it may increase the GDP if the inputs used
for production have become cheaper to import increasing aggregate supply.

II. Expansionary/Reflationary of the exchange rate

An increase in money supply leads to a rise in availability of funds for loans,
leading to lower costs of burrowing. This encourages firms and consumers to
take out more loans for investments and consumption. While this boost in
aggregate demand raises levels of output within an economy, it also pushes up
the inflation rate.

Figure 3

III. Depreciation/Devaluation of the Exchange Rate

A fall in the exchange rate would raise net exports, leading to more aggregate
demand as more exports are demanded from abroad. However, the costs of
imports will rise leading to more inflationary pressure in the economy.
Although, just as it was with the rise of exchange rate, here whether
depreciation/devaluation is a net gain or loss will be dependent upon the price
elasticity of demand of imports and exports.

Objectives of Monetary policy:

1. To ensure Price Stability.
2. To encourage Economic Growth.
3. To ensure stability of exchange rate of money.

Tools for Monetary Policy:

1. Open Market Operations: The purchase and sale of securities in the
open market by a central bank.
2. Discount Rate: The interest rate charged to commercial banks on loans
they receive from their regional Federal Reserve Bank's lending facility.
3. Change In Reserve Ratio: The percentage of a commercial bank's
deposits that it must keep in cash as a reserve.
 • Monetary policy by PTI 2022

Early January 2022:
In early 2022 the State Bank of Pakistan Amendment Bill 2021 was enacted,
which will prevent the SBP from providing the government with any loans.
Although the government may still procure loans from commercial banks
within the country. This policy was one of the requirements that Pakistan
had agreed to meet under the IMF programme in July 2019.

24th January 2022:
1. On January 24, 2022, the Monetary Policy Committee (MPC) decided
to maintain the policy rate at 9.75 percent, in line with the forward
guidance provided in the last monetary policy statement. At that
time, the MPC had considered the measures taken to lower inflation
and keep the ongoing economic recovery sustainable. These
measures include a cumulative 275 basis point increase in the policy
rate, higher bank cash reserve requirements, regulatory tightening of
consumer finance, and curtailment of nonessential imports.
2. Since the last meeting on 14thDecember 2021, several developments
suggest that these demand moderating measures are gaining traction
and have improved the outlook for inflation. Recent economic
growth indicators are appropriately moderating to a more
sustainable pace. While year on year headline inflation is high and
will likely remain so in the near term due to base effects and energy
prices, the momentum in inflation has slowed with month-on-month
inflation flat in December compared to a significant rise of 3 percent
in November. Inflation expectations of businesses have also declined
considerably. The current account deficit appears to have stopped
growing since November and the nonoil current account balance is
expected to achieve a small surplus for FY22. Finally, and importantly,
the enactment of the recent Finance (Supplementary) Act,
 2022represents significant additional fiscal consolidation compared
to the budget and has lowered the outlook for inflation in FY23.
3. Looking ahead, and against the backdrop of these developments that
have improved the inflation outlook, the MPC was of the view that
current real interest rates on a forward-looking basis are appropriate
to guide inflation to the medium-term range of 5-7 percent, support
growth, and maintain external stability. If future data outturns
require a fine tuning of monetary policy settings, the MPC expected
that any change would be relatively modest.
4. In reaching its decision, the MPC considered key trends and prospects
in the real, external, and fiscal sectors, and the resulting outlook for
monetary conditions and inflation.

8th March 2022:

1. On March,8 2022, the Monetary Policy Committee (MPC) decided to
maintain the policy rate at 9.75 percent. This decision reflected the
MPC’s view that the outlook for inflation has improved following the
cuts in fuel prices and electricity tariffs announced last week as part of
the government’s relief package. At the same time, high-frequency
indicators suggest that growth continues to moderate to a more
sustainable pace. This moderation should help keep at bay demand side
pressures on inflation and contain nonoil imports, notwithstanding the
significant uncertainty about the future path of global energy and food
prices due to the Russia Ukraine conflict.

2. Since the last MPC meeting on 24thJanuary 2022, headline inflation

moderate din February to 12.2 percent (y/y). Inflation in February would
have been noticeably lower were it not for abnormal increases in a few
perishable items. Accordingly, core inflation also felling urban areas and
inflation expectation shave remained stable, suggesting that second-
round effects from higher commodity prices remain contained. On the
external front, despite the rise in global prices, the February trade deficit
witnessed a further 10percent contraction(m/m) on top of the
29percent decline recorded in January, confirming the slowdown in
domestic demand. While the current account deficit rose in January, this
 largely reflected lumpy imports of oil, vaccines and other items financed
through loans and supplier credit. Excluding these imports, the deficit
would have been about$1billion lower, suggesting that the underlying
trend in the current account balance is also moderating.

3. Looking ahead, the MPC noted that while current real interest rates on a
forward-looking basis are appropriate to guide inflation to the medium-
term range of 5-7 percent, support growth, and maintain external
stability, the Russia Ukraine conflict has introduced a high degree of
uncertainty in the outlook for international commodity prices and global
financial conditions. Continued adverse conditions on these fronts could
pose challenges to the outlook for the current account deficit and
inflation expectations, which could necessitate changes in the policy
rate. Since the Russia-Ukraine situation remains fluid, the MPC noted
that it was prepared to meet earlier than the next scheduled MPC
meeting in late April, if necessary, to take any needed timely and
calibrated action to safeguard external and price stability.

4. In reaching its decision, the MPC considered key trends and prospects in
the real, external, and fiscal sectors, and the resulting outlook for
monetary conditions and inflation

April 2022:
1. On 8thMarch 2022, the Monetary Policy Committee (MPC) noted in its
statement the significant uncertainty around the outlook for
international commodity prices and global financial conditions, which
had been exacerbated by the Russia-Ukraine conflict. Given the
unfolding situation, the MPC had highlighted that it “was prepared to
meet earlier than the next scheduled MPC meeting in late April, if
necessary, to take any needed timely and calibrated action to safeguard
external and price stability.”
2. Since the last MPC meeting, the outlook for inflation has deteriorated
and risks to external stability have risen. Externally, futures markets
suggest that global commodity prices, including oil, are likely to remain
elevated for longer and the Federal Reserve is likely to increase interest
rates more quickly than previously anticipated, likely leading to a
sharper tightening of global financial conditions. On the domestic front,
the inflation out-turn in March surprised on the upside, with core
inflation in both urban and rural areas also rising significantly. While
timely demand-moderating measures and strong exports and
remittances saw the February current account deficit shrink to $0.5
billion, its lowest level this fiscal year, heightened domestic political
uncertainty contributed to a 5 percent depreciation in the rupee and a
sharp rise in domestic secondary market yields as well as Pakistan’s
Eurobond yields and CDS spreads since the last MPC meeting. In
addition, there has been a decline in the SBP’s foreign exchange reserves
largely due to debt repayments and government payments pertaining to
settlement of an arbitration award related to a mining project. Some of
this decline in reserves is expected to be reversed as official creditors
renew their loans.

3. As a result of these developments, average inflation forecasts have been

revised upwards to slightly above 11 percent in FY22 before moderating
in FY23. The current account deficit is still expected to be around 4
percent of GDP in FY22. While the nonoil current account balance has
continued to improve, the overall current account remains dependent
on global commodity prices.

4. The MPC noted that the above developments necessitated a strong and
proactive policy response. Accordingly, the MPC decided at its
emergency meeting today, to raise the policy rate by 250basis points to
12.25percent. This increases forward-looking real interest rates (defined
as the policy rate less expected inflation) to mildly positive territory. The
MPC was of the view that this action would help to safeguard external
and price stability. The MPC also noted that SBP is in the process of
taking further actions to reduce pressures on inflation and the current
 account, namely an increase in the interest rate on the export refinance
scheme (EFS) and widening the set of import items subject to cash
margin requirements. These items are mostly finished goods including
luxury items and exclude raw materials. The announcement of these
measures is expected soon and will complement the action taken by the
MPC on interest rates today.

5. Importantly, the MPC highlighted that Pakistan’s external financing

needs in FY22 are fully met from identified sources. Looking ahead, the
MPC noted that today’s decisive actions, together with a reduction in
domestic political uncertainty and prudent fiscal policies, should help
ensure that Pakistan’s robust economic recovery from Covid19remains
sustainable.

• Monetary policy by PMLN 2022

May 23, 2022:

Monetary Policy Committee (MPC) decided to raise the bank rate to 13.75
percent to help moderate demand to a more sustainable pace while keeping
inflation expectations anchored and containing risks to external stability. The
interest rates on EFS and Long-Term Financing Facility LTFF loans are also being
raised.

July 7, 2022:
1. Monetary Policy Committee (MPC) decided to raise the bank to 15
percent EFS and LTFF loans are now being linked to the policy rate to
strengthen monetary policy transmission.
2. Despite the dampening effect of monetary tightening (raising interest
rates), inflation is likely to remain elevated around current levels for
 much of FY23(financial year) due to the large supply shock associated
with the necessary reversal of fuel and electricity subsidies.

5th August 2022:

1. It is pertinent to mention that under the International Monetary Fund
(IMF) programme, the government cannot borrow directly from the SBP.
Thus, the central bank injects this liquidity into commercial banks, which
use these funds to purchase government securities. The State Bank of
Pakistan (SBP) has injected Rs996 billion worth of liquidity into the
money market via an open market operation (OMO) through a reverse
repo, it said on Friday.

August 22, 2022:

1. MPC decided to keep bank rate at 15%. Pakistan has secured an
additional $4 billion from friendly countries over and above its external
financing needs in FY23. As a result, FX (Forex) reserves will be further
augmented through the course of the year, helping to reduce external
debt.
2. Foreign exchange reserves have fallen from $16.4 billion in February to
$7.9 billion on August 12th. The inflow was reduced due to the lack of
money burrowing caused by delay in the completing the review of the
IMF program because of policy slippages.

October 10, 2022:

1. Bank rate again remains constant at 15%. MPC is of the view that the
existing monetary policy is a fine balance between managing inflation
and maintaining growth in the wake of the floods, despite the fear of
supply shock of agriculture products due to the flooding.
 2. MPC noted the desired moderation in economic activity has become
more visible, signalling that the tightening measures implemented over
the last year are gaining traction.
3. The Rupee has recouped some of its losses following the recent
depreciation, possibility due to foreign investors trying to take
advantage of the higher interest rates. The combined 7th and 8th review
under the on-going IMF program was successfully completed on August
29th, releasing a part of the $1.2 billion. Pakistan’s cash reserve
requirement is set at 5%.

Conclusion

The State bank adopted a policy of Contractionary/Deflationary monetary

policy, with prime goal of combating inflation within Pakistan’s economy.
 References:
• Cambridge International as and a Level Economics by Peter
Smith
• Cambridge International AS and A Level Economics by Colin
Bamford, Susan Grant
• https://www.dawn.com/news/1671929 Figure 2 and 3 were
taken from
http://www2.harpercollege.edu/mhealy/eco212i/lectures/ch1
6-18.htm
• N. Gregory Mankiw - Principles of Economics
• https://www.brecorder.com/news/40190317/sbp-injects-
rs996-billion-in-omo
• https://www.sbp.org.pk/m_policy/2022/MPS-Apr-2022-
Eng.pdf
• https://www.sbp.org.pk/m_policy/2022/MPS-May-2022-
Eng.pdf
• https://www.sbp.org.pk/m_policy/2022/MPS-Jul-2022-Eng.pdf
• https://www.sbp.org.pk/m_policy/2022/MPS-Aug-2022-
Eng.pdf