KARACHI: The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) on Monday cut the key policy rate by 100 bps to 19.5 percent effective from July 30, 2024 as economic developments are favourable for the inflation outlook.
This is the second and cumulatively 2.5 percent cut in the key policy rate by the committee as in the previous meeting held on June 10, 2024, the rate was reduced by 150 bps to 20.5 percent from the all-time high level of 22 percent.
Addressing a press conference after the committee meeting on Monday at SBP head office, Governor SBP Jameel Ahmed said that inflation has significantly declined from 38 percent (May 20243) to 12.6 percent in June 2024, which was slightly better than anticipated. 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. Therefore, the committee has decided to further cut the policy rate by 100 bps, he added.
He informed that the Committee also assessed that the inflationary impact of the FY25 budgetary measures was broadly in line with earlier expectations. In addition, 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.
“Considering these developments along with a significantly positive real interest rate the Committee viewed that there was a room to further reduce the policy rate in a calibrated manner to support economic activity, while keeping inflationary pressures in check,” Governor said.
He said that on balance, after considering current 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.
He informed that real GDP growth is projected in the range of 2.5 to 3.5 percent in FY25 as compared to 2.4 percent recorded last year due to strong performance of the agriculture sector and recovery in activities of the industry and services supported by relatively lower interest rates and higher budgeted development spending.
After recording surpluses for three consecutive months, the current account posted a deficit in May and June 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, he mentioned.
Cumulatively, the Governor said that the current account deficit in FY24 narrowed significantly to 0.2 percent of GDP from 1.0 percent in the preceding year. This, along with the revival of financial inflows, helped build the SBP’s FX reserves.
He said that despite some modest increase in imports, the current account deficit is expected to contain and will be in the range of 0-1.0 percent of GDP in FY25 supported by continued robust growth in workers’ remittances, along with an increase in exports.
The committee also noted that since the last MPC meeting, there were a number of developments on the economic front. First, the current account deficit narrowed sharply in FY24 and SBP’s FX reserves improved significantly from $4.4 billion at end-June 2023 to above $9.0 billion.
Second, the country reached a staff level agreement with the IMF for a 37-month EFF program of about $7.0 billion. Third, sentiment surveys conducted in July showed a worsening in inflation expectations and confidence of both consumers and businesses.
Fourth, 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 these developments, the Committee assessed that, despite the rate cut decision, the monetary policy stance remains adequately tight to guide inflation towards the medium-term target of 5-7 percent. This 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.
According to the Monetary Policy Statement, slight increase in June inflation compared to May 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 percent over the past two months.
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.
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 on 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 percent of GDP.
The MPC emphasised on achieving the envisaged fiscal consolidation and timely realization of planned external inflows to support overall macroeconomic stability, and build fiscal and external buffers for the country to respond to future economic shocks. The MPC 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 percent and 2.6 percent, 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 percent at end-June 2023 to 33.6 percent at end-June 2024.
At the same time, the improvement in external accounts 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.
Copyright Business Recorder, 2024
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