The State Bank of Pakistan (SBP) on Monday cut the interest rate from 20.5% to
19.5%, marking the second consecutive reduction, in response to easing inflation
and market expectations.
Addressing a press conference after the Monetary Policy Committee (MPC)
meeting, SBP Governor Jameel Ahmad said, “We have noted that the inflation is
on a declining trend.”
“The inflation rate has come down to 12.60% from 38% while the external
account has continued to improve,” the SBP governor said adding, “The
reduction in the interest rate reflects our confidence in the current economic
trajectory.”
Last month, the SBP’s MPC trimmed its benchmark interest rate by 150 bps to
20.5%, following a record-high 22% that had been maintained for almost a year.
The finance czar further stated that “future projections expect the average
inflation rate to stabilise between 23% and 25%, following last year’s 23.4%”.
The central bank in a statement said the announcement of monetary easing
showed positive indicators for the national economy citing a slight drop in
inflation, a build-up in SBP’s foreign exchange (FX) reserves despite repayments
of debt, and a staff-level agreement with the International Monetary Fund (IMF)
for a 37-month extended fund facility (EFF) programme of about $7.0 billion.
It added that the committee assessed that the external account has continued to
improve, as reflected by the build-up in the central bank’s FX reserves despite
substantial repayments of debt and other obligations.
The developments – along with significantly positive real interest rates – led to
the further reduction in the policy rate in a calibrated manner to support
economic activity, while keeping inflationary pressures in check.
Since its last meeting, the committee noted the key developments that the current
account deficit narrowed sharply in FY24 and SBP’s FX reserves improved
significantly from $4.4 billion at the end of June 2023 to above $9.0 billion.
The sentiment surveys conducted in July showed a worsening in inflation
expectations and confidence of both consumers and businesses, the statement
read.
It adds that international oil prices have remained volatile in recent weeks,
whereas prices of metals and food items have eased.
Lastly, with the ease in inflationary pressures and labour market conditions,
central banks in advanced economies have also started to cut their policy rates.
Taking stock of the developments, the MPC assessed that, despite today’s
decision, the monetary policy stance remains adequately tight to guide inflation
towards the medium-term target of 5% – 7%.
The assessment is also contingent on achieving the targeted fiscal consolidation,
timely realisation of planned external inflows and addressing underlying
weaknesses in the economy through structural reforms, it added.
Real sector
“Latest high-frequency indicators continue to reflect moderate economic activity.
Auto and POL (excluding FO) sales and fertiliser offtake increased on a month-
on-month basis in June. Large-scale manufacturing also recorded a sharp
improvement in May 2024, mainly driven by the apparel sector.”
“The growth in agriculture sector, after showing a strong performance in FY24,
is expected to slow down in this fiscal year. Latest satellite images and input
conditions for Kharif crops also support this assessment.”
However, activity in the industry and services sectors is expected to recover,
supported by relatively lower interest rates and higher budgeted development
spending. Based on this, the MPC assessed FY25 real GDP growth in the range
of 2.5% to 3.5% as compared to 2.4% recorded last year.
External sector
After recording surpluses for three consecutive months, the current account
posted a deficit in May and June, in line with the MPC’s expectation. The
recorded deficits were largely due to higher dividend and profit payments and a
seasonal increase in imports, which more than offset a significant increase in
exports and workers’ remittances.
Cumulatively, the current account deficit in FY24 narrowed significantly to 0.2%
of GDP from 1.0% in the preceding year. This, along with the revival of financial
inflows, helped build the SBP’s FX reserves.
Looking ahead, the MPC expects a modest increase in imports, in line with the
growth outlook.
At the same time, the continued robust growth in workers’ remittances, along
with an increase in exports, is expected to contain the current account deficit in
the range of 0 – 1.0% of GDP in FY25.
The committee assessed that the expected financial inflows, including planned
official flows under the IMF program, would help finance this current account
deficit and further strengthen the FX buffers.
Fiscal sector
The government’s revised estimates indicate improvement in fiscal balances
during FY24, as the primary balance turned into a surplus and the overall deficit
declined from last year. However, amidst a shortfall in budgeted external and
non-bank financing, the government’s reliance on the domestic banking system
increased significantly.
The committee expressed concern about increasing reliance on banks for deficit
financing, which has been squeezing borrowing space for the private sector.
For FY25, the government has set the primary surplus target at 2.0% of the GDP.
The MPC emphasised achieving the envisaged fiscal consolidation and timely
realisation of planned external inflows to support overall macroeconomic
stability and build fiscal and external buffers for the country to respond to future
economic shocks.
Money and credit
The committee noted that the trends and composition of monetary aggregates
during FY24 remained consistent with the tight monetary policy stance.
Broad money (M2) and reserve money grew by 16.0% and 2.6%, respectively,
well below the growth in nominal GDP. Almost the entire growth in M2 was led
by bank deposits, while currency in circulation remained almost at last year’s
level.
As a result, the currency-to-deposit ratio improved, as it declined from 41.1% at
end-June 2023 to 33.6% at end-June 2024.
At the same time, the improvement in external account increased the contribution
of net foreign assets in monetary expansion.
Meanwhile, the growth in net domestic assets of the banking system decelerated
amidst subdued demand for private sector credit. The Committee viewed these
developments as favourable for the inflation outlook, the statement read.
Inflation outlook
As expected, headline inflation rose to 12.6% on a year-on-year basis in June
2024 from 11.8% in May. This increase was primarily driven by higher
electricity tariffs and Eid-related increase in prices, which were partly offset by
the downward adjustments in domestic fuel prices.
Core inflation, meanwhile, has steadied around 14% over the past two months.
The MPC assessed that while the inflationary impact of the FY25 budget is
largely in line with expectations, the available information indicates that the full
impact of these measures may now take some time to fully reflect in domestic
prices.
At the same time, the Committee noted risks to the inflation outlook from fiscal
slippages and ad-hoc decisions related to energy price adjustments.
On balance, after considering these trends – and accounting for the sufficiently
tight monetary policy stance and ongoing fiscal consolidation – average inflation
is expected to remain in the range of 11.5 – 13.5% in FY25, down significantly
from 23.4% in FY24.