The State Bank of Pakistan (SBP)’s Monetary Policy Committee (MPC) on Monday cut the interest rate by 100 basis points, the sixth consecutive reduction to the policy rate.
Overall, the central bank has slashed the interest rate by 850 basis points in seven months of fiscal year 2024-25, the largest cut in any given fiscal year.
In its meeting, MPC reduced the policy rate from 13 to 12 percent, effective from Jan. 28. In a statement, it noted that inflation continued to trend downward in line with expectations, reaching 4.1% year-on-year in December. It attributed this decline to moderate domestic demand conditions and supportive supply-side dynamics, amidst a favorable base effect.
Since its last meeting, the MPC noted real GDP growth in the first quarter of fiscal year 2024-25 was slightly lower than earlier expectations, while the current account had been in surplus in December 2024. However, it said, the central bank’s foreign exchange reserves had declined amidst low financial inflows and high debt repayments.
The MPC further noted that despite a substantial increase in December, tax revenues for the first half of the ongoing fiscal had remained below target. It said global oil prices had exhibited heightened volatility over the past few weeks, stressing the global economic policy environment has become more uncertain, prompting central banks to adopt a cautious approach.
Considering these developments and evolving risks, read the statement, the MPC had perceived that a cautious monetary policy stance was necessary to ensure price stability and sustainable economic growth. In this regard, the MPC assessed that the real policy rate needs to remain adequately positive on a forward-looking basis to stabilize inflation in the target range of 5-7 percent.
Real Sector
According to the MPC, the provisional data of real GDP for Q1-FY25 showed a modest growth of 0.9% against the 2.3 percent growth recorded in Q1-FY24. It attributed this slowdown to an expected sharp deceleration in agriculture sector growth to 1.2% in Q1-FY25, against 8.1% in the same period last year. It noted latest available information for wheat crop also pointed to a relatively modest output.
The decline in industrial sector growth in Q1-FY25 also moderated relative to last year, with the MPC noting the downtrend in large-scale manufacturing was driven by a few low-weight items, such as furniture. By contrast, key industrial sectors such as textile, food and beverages, and automobiles had shown noticeable improvement. It noted, however, the business confidence index had continued to show positive sentiments. Going forward, the MPC expected economic activity to gain further traction and real GDP growth to remain in the earlier projected range of 2.5-3.5%.
External Sector
Driven by strong workers’ remittances and export earnings, the current account posted a surplus of $0.6 billion in December, bringing the cumulative surplus during the first half of FY2024-25 to $1.2 billion. Led by HVA textile, exports maintained a strong momentum, it said, while import growth also showed broad-based acceleration on the back of higher volumes, pointing towards improvement in economic activity.
The MPC said the import bill had outpaced export earnings, but remittances’ inflows more than offset the widening trade deficit. Based on these trends, particularly remittances, the outlook for the current account balance had improved considerably and is now expected to remain between a surplus and a deficit of 0.5% of GDP in FY25.
Meanwhile, net financial inflows, though tepid during H1-FY25, are expected to improve going forward as a sizable part of official debt repayments has already been made. Consequently, the improved current account outlook, along with the expected realization of planned financial inflows, is likely to increase the SBP’s FX reserves beyond $13 billion by June 2025.
Fiscal Sector
The central bank said revenues of the Federal Board of Revenue (FBR) had recorded a notable increase of around 26% during H1-FY25. However, it said, the shortfall in collection from the target had widened. Accordingly, a steep acceleration in tax revenue growth would be required to achieve the annual target, it said.
It said estimates from the financing side suggested an improvement in the fiscal balance during H1-FY25, indicating relatively contained expenditures. The MPC viewed that the anticipated lower interest payments than the budgeted amount was likely to contain the overall fiscal deficit around its target. However, achieving the target for the primary balance would be challenging.
Inflation
Headline inflation continued its downward trajectory, easing to 4.1% year-on-year in December from 4.9% in November. The decline was attributed to the downward adjustment in electricity tariffs; adequate supply of key food items reducing food inflation; stability in exchange rate; and favorable base effect. Underlying inflationary pressures, as indicated by core inflation, also moderated amidst contained domestic demand, though these remain elevated.
Moreover, inflation expectations also remained volatile. Based on these trends, the MPC reiterated its earlier assessment that the near-term inflation will remain volatile and increase close to the upper bound of the target range towards the end of the ongoing fiscal year. On balance, the MPC expects headline inflation for FY25 to average between 5.5-7.5%.
Going forward, the inflation outlook is subject to risks emanating from volatile global commodity prices, protectionist policies in major economies, timing and magnitude of administered energy tariff adjustments, volatile perishable food prices, as well as any additional measures to meet the revenue target.