The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) has reduced the key policy rate by 100 basis points, taking it to 19.5%, its second successive decision of a cut.

“We have noted that the inflation is on a declining trend,” SBP Governor Jameel Ahmad said as he addressed a press conference after the MPC meeting on Monday.

In a statement issued separately, the MPC observed that the June 2024 inflation was slightly better than anticipated.

“The Committee also assessed that the inflationary impact of the FY25 budgetary measures was broadly in line with earlier expectations,” the SBP statement added.

It said that the external account has continued to improve, as reflected by the build-up in SBP’s foreign exchange reserves despite substantial repayments of debt and other obligations.

“Considering these developments – along with significantly positive real interest rate – the Committee viewed that there was room to further reduce the policy rate in a calibrated manner to support economic activity, while keeping inflationary pressures in check,” it said.

The MPC was of the view that despite the latest rate cut, the monetary policy stance remains “adequately tight to guide inflation towards the medium-term target of 5–7%”.

“This assessment is also contingent on achieving the targeted fiscal consolidation, timely realization ofplanned external inflows and addressing underlying weaknesses in the economy through structural reforms.”

The committee stated that sentiment surveys conducted in July showed a worsening in inflation expectations and confidence of both consumers and businesses.

During his press conference, the SBP chief said the central bank expects Pakistan to record GDP growth of 2.5-3.5% in FY25.

Outlook on inflation

Pakistan has been hit by runaway inflation in recent years with the CPI-based figure hitting a record high of 38% in May last year. That reading has since slowed, but is still nowhere near the medium-term target set by the SBP.

In fact, the reading also increased in June 2024 when compared with the previous month, and the SBP said the the increase 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.

“The 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. On balance, after considering these 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.”

Background

This was the first policy meeting following the signing of a staff-level agreement with the International Monetary Fund (IMF) and the federal budget.

With inflation reading registering a significant decline and the commencement of policy rate cuts by central banks worldwide, majority of the market had expected Pakistan’s central bank to further ease its monetary stance.

In its previous meeting held on June 10, the SBP reduced the key policy rate by 150 basis points (bps), taking it to 20.5%. This was the central bank’s first rate cut in the last four years.

Economic activity has been slow in the South Asian country for the last two years after the government implemented tough reforms under an IMF bailout in a bid to stabilise a crumbling economy.

However, the phase is not yet over as Islamabad has again inked a new, longer-term bailout with the international lender, after completing a short-term programme earlier this year that helped the nation avoid a default.

Earlier this month, the IMF and the Pakistani authorities reached a staff level agreement (SLA) for a $7-billion, 37-month loan programme aimed at cementing stability and inclusive growth.

Analysts’ expectations

A majority of market experts were of the view that the central bank might opt for easing of monetary policy amid a downward trajectory of the inflation rate.

Some had said that developments including a fall in CPI inflation, a manageable current account, a stable currency and improved external reserves could be factors advocating a rate cut.

A report by brokerage house Arif Habib Limited (AHL) – in which it cited a poll result that suggested 55.7% respondents expect the central bank to “reduce the policy rate”– said market sentiment also suggests expectations of a further easing in the SBPs monetary policy.

“We’re expecting a 100bps cut that could lower the policy rate to 19.5%, a level not seen since March 2023,” AHL said in its report.

Since the last MPC, two significant events have occurred including the announcement of the FY25 Budget and Pakistan’s entry into a new 37-month Extended-Fund Facility (EFF) programme worth $7 billion with the IMF, the brokerage house noted.

Moreover, key improvements in macroeconomic indicators of late have bolstered expectations of a rate cut, it added.

Meanwhile, another brokerage house Topline Securities also suggested a similar expectation.

“We are also of the view that the SBP can lower the rate by 100bps to 19.5% in its upcoming meeting due to receding inflation,” Shankar Talreja of Topline Securities in a report.

Previous MPC meeting

In its previous meeting on June 10, the MPC had cut its key interest rate by 150 bps from an all-time high of 22%, which was in line with market expectations.

“The MPC assessed that underlying inflationary pressures are also subsiding amidst a tight monetary policy stance, supported by fiscal consolidation. This is reflected by continued moderation in core inflation and ease in inflation expectations of both consumers and businesses in the latest surveys,” the MPC had stated back then.

Since the last MPC in June, several key developments on the economic front took place.

The rupee depreciated a marginal 0.02%, while petrol prices increased nearly 3%.

Internationally, oil prices remained largely stable and were hovering near $80 per barrel, despite geopolitical volatility.

The Consumer Price Index (CPI)–based inflation clocked in clocked in at 12.6% on a year-on-year basis in June 2024, the Pakistan Bureau of Statistics (PBS) data revealed, higher than the reading in May when it stood at 11.8%.

In addition, Pakistan’s current account posted a deficit of $681 million in FY2023-2024, massively lower by 79% than the deficit of $3.275 billion in the previous fiscal year.

Foreign exchange reserves held by the SBP decreased by $397 million on a weekly basis, clocking in at $9.02 billion as of July 19, data released on Thursday showed.

Total liquid foreign reserves held by the country stood at $14.33 billion. Net foreign reserves held by commercial banks stood at $5.31 billion.