The State Bank of Pakistan (SBP)’s Monetary Policy Committee (MPC) on Monday cut the policy rate by 100 basis points, reducing it from 20.5 to 19.5 percent, on the back of declining inflation and an improvement in the external account.
In a statement, the MPC said inflation in June 2023 was “slightly” better than anticipated and it had found the inflationary impact of new budgetary measures broadly in line with earlier expectations. “The external account has continued to improve, as reflected by the build-up in SBP’s FX reserves despite substantial repayments of debt and other obligations,” it said, noting these developments coupled with “significantly positive real interest rate” had created space to reduce the policy rate in a calibrated manner to support economic activity.
According to the MPC, it had noted a significant shrinkage of the current account deficit in the last fiscal, while the SBP’s FX reserves improved significantly from $4.4 billion at end-June 2023 to over $9 billion today. Since its last meeting, it said Islamabad had inked a staff level agreement with the IMF for a 37-month $7 billion program, while sentiment surveys conducted in July showed a worsening in inflation expectations and confidence of both consumers and businesses.
Additionally, it noted the volatility of international oil prices in recent weeks even as prices of metals and food items eased. The easing of inflationary pressures and labor market conditions, it said, had seen central banks in advanced economies also cutting their policy rates. It said that factoring in these developments, the monetary policy stance remained was sufficient to guide inflation toward the medium-term target of 5-7 percent. “This assessment is also contingent on achieving the targeted fiscal consolidation, timely realization of planned external inflows and addressing underlying weaknesses in the economy through structural reforms,” it stressed.
In the real sector, it noted that recent indicators reflected moderate economic activity, including sales of petroleum products, automobiles and fertilizer. “Large-scale manufacturing also recorded a sharp improvement in May 2024, mainly driven by the apparel sector,” it said, while cautioning that the agriculture sector was expected to slow down this year. “However, activity in the industry and services sectors is expected to recover, supported by relatively lower interest rates and higher budgeted development spending,” it said, reiterating it expected GDP growth of 2.5-3.5% this year against the 2.4% recorded last year.
For the external sector, the MPC noted that the current account had posted a deficit in May and June after three consecutive months of surplus. “These 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,” it said, while noting its reduction in the last fiscal coupled with financial inflows had helped build the SBP’s FX reserves. It said that while it expected a modest increase in imports, a rise in workers’ remittances and exports should contain the current account deficit within a percent of GDP in the current fiscal.
On the fiscal sector, the MPC noted a shortfall in budgeted external and non-bank financing had led to an increased government reliance on the domestic banking system. “The Committee expressed concern on increasing reliance on banks for deficit financing, which has been squeezing borrowing space for the private sector,” it said, adding the government should ensure it remains within its primary surplus target of 2% of GDP for overall macroeconomic stability and provision of buffers to help offset any future economic shocks.
The MPC also noted that broad money and reserve money had grown by 16% and 2.6%, respectively, well below the growth in nominal GDP. “Almost the entire growth in [broad money] was led by bank deposits, while currency in circulation remained almost at last year’s level,” it said, adding this had improved the currency to deposit ratio, with it declining 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,” it added.
The MPC’s inflation outlook stated that, as expected, headline inflation rose to 12.6% year-on-year in June 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,” it said, while noting core inflation had stabilized around 14 percent 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,” it warned, noting risks to the 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 percent in FY25, down significantly from 23.4 percent in FY24,” it added.