UPDATE 2-Pakistan central bank raises key interest rate to 13.25%

Pakistan's central bank raised its main policy rate by 100 basis points on Tuesday to 13.25%, citing increased inflationary pressures and a likely near-term rise in prices from higher utility costs. The increase follows this month's accord with the International Monetary Fund on a $6 billion loan package that comes with tough conditions aimed at cutting Pakistan's substantial fiscal and current account deficits and bolstering its shrinking currency reserves.

State Bank of Pakistan Governor Reza Baqir said the decision to raise rates took into account upside inflationary pressures and the impact from recent increases in utility prices passed under the government's recent budget. The central bank has now increased its main policy rate nine times since the beginning of last year, raising it by a total of 750 basis points as it has struggled to control inflation, a widening fiscal deficit and pressure on the rupee currency.

Inflation eased slightly last month to 8.9% but Baqir said he expected pressures to continue with inflation averaging 11-12% in the current fiscal year, higher than previously expected, before falling considerably in 2021. The central bank said real interest rates implied by these inflation projections and Tuesday's rate rise were "at appropriate levels considering the cyclical weakening of aggregate demand".

Under the bailout accord, the IMF said it expected "appropriately tight monetary policy" would bring inflation down to 5-7% in the medium term. With slowing growth, a budget deficit that has climbed to more than 7% of gross domestic product (GDP) and currency reserves of about $8 billion following the first tranche of the IMF loan, Pakistan has been struggling to ward off a debt and balance of payments crisis for more than a year.

After initial reluctance, Prime Minister Imran Khan's government turned to the IMF for support and finalized a $6 billion loan agreement this month that will unlock an additional $38 billion in loans from other international partners. The three-year agreement for Pakistan's 13th IMF bailout since the late 1980s has seen a sharp drop in the value of the rupee that has added to inflationary pressures after the central bank agreed to a "flexible, market-determined exchange rate".

However, the central bank said it stood ready to take action to address any "disorderly market conditions" in the foreign exchange market. The accord also foresees structural economic reforms and a widening of the tax base to boost chronically weak tax revenues.

Under a budget agreed with the IMF, the government raised utility prices, which the central bank said would lead to a one-time considerable rise in prices in the first half of the year. It said the government's commitment under the IMF program to stop borrowing from the central bank would "qualitatively improve the inflation outlook".

The central bank said it expected real GDP growth of about 3.5 percent in the year to June.