KARACHI: The State Bank of Pakistan (SBP) on Monday cut interest rate by 1% or 100 basis points (bps) from 20.5% to 19.5%, the second cut in a row, citing a slight cooling in inflation rates – and a step , which is mostly in line with the general market consensus.
Speaking at a press conference after the Monetary Policy Committee (MPC) meeting, SBP Governor Jameel Ahmad said, “We have noticed that inflation is on a downward trend.”
“The rate of inflation eased to 12.60% from 38% while the external account continued to improve,” the SBP governor said, adding, “The rate cut reflects our confidence in the current economic trajectory.”
Last month, the MPC SBP cut its benchmark interest rate by 150 bps to 20.5%, after a record high of 22% held for almost a year.
The finance czar went on to say that “future projections expect the average inflation rate to stabilize between 23% and 25%, after last year’s 23.4%.
In a statement, the central bank said the monetary policy easing announcement showed positive indicators for the national economy, citing a modest decline in inflation, the accumulation of foreign exchange (FX) reserves by the SBP despite debt repayments and a staff-level agreement with the International Monetary Fund (IMF) on a 37-month enhanced funds (EFF) program of approximately $7.0 billion.
He added that the committee assessed that the external account continued to improve, reflected in the increase in the central bank’s foreign exchange reserves despite significant debt repayments and other liabilities.
These developments – together with significantly positive real interest rates – led to further reductions in the monetary policy rate to support economic activity while keeping inflationary pressures at bay.
Since its last meeting, the committee noted a key development that the current account deficit narrowed sharply in FY24 and SBP’s foreign exchange reserves improved significantly from USD 4.4 billion at the end of June 2023 to over USD 9.0 billion.
Sentiment surveys conducted in July showed a deterioration in inflation expectations and consumer and business confidence.
It adds that international oil prices have remained volatile in recent weeks, while metal and food prices have eased.
Finally, as inflationary pressures and labor market conditions eased, central banks in advanced economies also began to reduce their monetary policy rates.
After assessing developments, the MPC considered that, despite today’s decision, the monetary policy setting remains sufficiently tight to steer inflation towards the medium-term target of 5-7%.
The assessment is also conditional on the achievement of targeted fiscal consolidation, the timely realization of planned external inflows and the solution of the basic weaknesses of the economy through structural reforms, he added.
“The latest high-frequency indicators continue to reflect moderate economic activity. Sales of cars and POL (without FO) and fertilizer consumption increased month-on-month in June. Large scale manufacturing also saw a sharp improvement in May 2024, mainly thanks to the apparel sector.
“Growth in the agriculture sector, after showing a strong performance in FY24, is expected to decelerate this fiscal. Latest satellite imagery and input conditions for Kharif crops also support this assessment.
However, activity in the industrial and service sectors is expected to pick up, supported by relatively lower interest rates and higher budgetary spending on development. Based on this, the MPC has assessed real GDP growth for FY25 in the range of 2.5% to 3.5%, 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 MPC expectations. The deficits recorded were largely due to higher dividend and profit payouts and a seasonal increase in imports that more than offset a significant increase in exports and worker transfers.
Cumulatively, the current account deficit narrowed significantly in FY24 to 0.2% of GDP from 1.0% in the previous year. This, along with a revival in financial inflows, helped build the SBP’s foreign exchange reserves.
Going forward, the MPC expects a slight increase in imports in line with growth prospects.
At the same time, continued strong growth in workers’ remittances, along with an increase in exports, is expected to contain a current account deficit of 0-1.0% of GDP in FY25.
The committee assessed that expected financial flows, including planned official flows under the IMF program, will help finance this current account deficit and further strengthen foreign exchange reserves.
Fiscal sector
The government’s revised estimates indicate an improvement in the fiscal balance during FY24 as the primary balance turned into a surplus and the overall deficit narrowed from last year. However, amid a deficit of budgeted external and non-bank financing, the government’s dependence on the domestic banking system increased significantly.
The Committee expressed concern over the increasing reliance on banks for deficit financing, which is reducing borrowing space for the private sector.
For FY25, the government has set a primary surplus target of 2.0% of GDP.
The MPC emphasized the achievement of projected fiscal consolidation and the timely realization of planned external inflows to support overall macroeconomic stability and build fiscal and external buffers to enable 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 a tight monetary policy stance.
Broad money (M2) grew by 16.0% and reserve money by 2.6%, well below nominal GDP growth. Almost the entire growth of M2 was driven by bank deposits, the currency in circulation remained almost at last year’s level.
As a result, the currency-to-deposit ratio improved, falling from 41.1% at the end of June 2023 to 33.6% at the end of June 2024.
At the same time, the improvement in the foreign account increased the contribution of net foreign assets to monetary expansion.
Meanwhile, growth in the banking system’s net domestic assets slowed amid subdued demand for private sector credit. The committee considered these developments to be favorable for the inflation outlook, the statement said.
Inflation outlook
Headline inflation is expected to rise to 12.6% year-on-year in June 2024 from 11.8% in May. This increase was mainly due to higher electricity tariffs and Eid-related price hikes, partially offset by downward revisions in domestic fuel prices.
Meanwhile, core inflation has settled at around 14% over the past two months.
The MPC assessed that while the inflationary impact of the FY25 budget is broadly in line with expectations, available information suggests that the full impact of these measures may now take some time to be fully reflected in domestic prices.
At the same time, the committee drew attention to risks for the inflationary outlook resulting from fiscal slippages and ad-hoc decisions related to energy price adjustments. consolidation – average inflation is expected to remain in the range of 11.5 – 13.5% in FY25, down significantly from 23.4% in FY24.
