The monetary policy meeting is on Monday, March 18, 2024 and analysts are divided on where they will be, some believe there would be a rate cut and others see status quo being maintained. There are no doubts that inflation is on a downward trajectory and the currency is stable. There is a consensus that interest rates will slowly begin to taper off now. The question is when will the easing cycle begin?

In March, the plausible outcome is that the monetary policy committee will keep the rate intact. There are reasons for this. The current real rates are still negative (where policy rate is at 22% and latest CPI reading is 23%), the IMF team is visiting Pakistan to conclude the second review, and globally inflation is seemingly upward sticky. However, around 200 bps cut cannot be ruled out in the review scheduled on 29th April 2024.

The main element to see is the economic demand and risks of it growing after monetary policy easing, and in turn, its impact on currency and money supply, and eventual impact on inflation. As of now, the demand destruction is real.

BR Research has contacted multiple banks’ treasury offices, and all are resonating with the fact that the import demand today is less than the restricted imports allowance last year – for example, last year (FY23) auto imports were reduced to half of FY22, and today in 8MFY24 the auto demand is 30 percent of 8MFY22. In addition, the petroleum imports are down by 30 percent from its levels in FY22. The discretionary consumer spending is significantly down and is visible across various sectors.

Thus today, the currency is stable mainly due to a genuine fall in demand, and it’s not due to any import restrictions. Even based on the current flows, some are expecting currency to appreciate. However, one should not forget, that not all the past payments (such as dividends of foreign shareholders in local firms, royalties, and contractual payments) are fully cleared and the pile is building up again. Thus, SBP should let surplus in the current account (if any) to facilitate clearance of past dues.

Hence, due to these pending payments and large sums of external debt servicing, there should not be any currency appreciation. And the REER is indicating that the PKR is slightly overvalued which is not a good sign, and slow depreciation cannot be ruled out.

The currency dynamics elude any aggressive cut which some are propagating based on lowering inflation due to base effect. The key is to see monthly numbers which were encouragingly at 0 percent in February 2024. The need is to see the trend to build up and let the inflation come down to 20 percent or lower before any rate cut.

Signaling is important. The country simply cannot afford any pick-up in demand due to peculiar balance of payment situation. Thus, keeping real rates positive on forward basis is a prudent choice, though it has repercussions on the borrowers.

The federal government is already spending more on interest expense than the net revenues it generates. There are earlier signs of loan defaults coming in the private sector – mainly in SMEs and small corporate. The private sector credit growth is in the negative. The GDP growth is expected to be less than the population growth rate on a low base (as last year GDP shrank in real terms), and unemployment is on a rise. The economy is coming to a screeching halt. These factors call for aggressive monetary easing.

Thus, to keep a delicate balance, slow and gradual easing is the order of the day, and SBP should move with extra cautioun and keep real rates positive on current inflation. Thus, expect around 200 bps cut in April, and SBP must maintain the policy rate on Monday.