Policy rate cut to 9 percent on virus fears

The Monetary Policy Committee (MPC) of State Bank of Pakistan (SBP) in its emergency meeting held on Thursday decided to further cut the key policy rate by 200 basis points (bps) to 9 percent to minimize the Coronavirus shock on economic growth. This is the third cut since last month.

The MPC had reduced the interest rate by 75 bps from 13.25 percent to 12.50 percent in its scheduled meeting on March 17, 2020. While, after one week on March 24, the MPC, called an emergent meeting in the wake of evolving economic impact of the Coronavirus and decided to cut the policy rate by 150 bps to 11 percent.

Now on Thursday, the third reduction in key policy rate was announced by the Committee to support the economy, which is expected to contract by -1.5 percent in FY20. Cumulatively, the MPC has cut the policy rate by 425 bps from 13.25 percent to 9 percent in one month to address the economic slowdown.

The Committee noted that while there is exceptionally high uncertainty about the severity and duration of the Coronavirus shock, the developments imply further downward revision in the outlook for growth and inflation. The economy is expected to contract by -1.5 percent in FY20 before recovering to around 2percent growth in FY21, it added.

According to monetary policy statement issued by SBP, the MPC decided at its emergency meeting to cut the policy rate by a further 200 basis points to 9 percent due to reduction in growth and inflation expectations.

This reduces forward looking real interest rates (defined as the policy rate less expected inflation) to around zero, which is about the middle of the range across most emerging markets.

The MPC was of the view that this action would cushion the impact of the Coronavirus shock on growth and employment, including by easing borrowing costs and the debt service burden of households and firms, while also maintaining financial stability.

The Committee believed that the policy rate cut would also help ensure that economic activity is better placed to recover when the pandemic subsides.

The MPC highlighted that this rate cut would complement other measures recently taken by the SBP to support the economy, including concessional financing to companies that do not lay off workers, one-year extension in principal payments, doubling of the period for rescheduling of loans from 90 to 180 days, and concessional financing for hospitals and medical centers incurring expenses to combat the Coronavirus pandemic.

Since the last MPC meeting, the global and domestic outlook has further deteriorated. The world economy is expected to enter into the sharpest downturn since the Great Depression, contracting by as much as 3 percent in 2020, according to projections released this week by the IMF, the statement said.

This is a much deeper recession than the 0.07 percent contraction during the global financial crisis in 2009. Moreover, there are severe risks of a worse outcome. In addition, global oil prices have plummeted further, with futures markets suggesting low prices will persist.

Domestically, high-frequency indicators of activity including retail sales, credit card spending, cement production, export orders, tax collections, and mobility data from Google's recently introduced Community Mobility Reports suggest a significant slowdown in most parts of the economy in recent weeks.

On the inflation front, the MPC noted that both the March CPI out-turn and more recent weekly SPI releases in April also show a marked reduction in inflation momentum.

Inflation is expected to be close to the lower end of the previously announced 11-12 percent range this fiscal year, and to fall to 7-9 percent range next fiscal year. While there are some upside risks to headline inflation in case of temporary supply disruptions or food price shocks, these are unlikely to generate strong second-round effects due to the weakness of the economy.

Similarly, the inflationary impact of the recent exchange rate depreciation is expected to be contained given low import demand and falling global prices.

It may be mentioned here that the MPC, in its last meeting on 24thMarch 2020, noted the worsening outlook for global and domestic economic activity in the wake of the Corona pandemic. Given the unfolding situation, the MPC said that it "remains ready to take whatever further actions become necessary in response to the evolving economic impact of the Coronavirus."

With current reduction, the policy rate has come into single digit after a gap of 14-month as previously it was in single digit in November 2018, when policy rate was 8.50 percent.