KARACHI: With inflation declining in line with its expectations, the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) on Monday announced 200 basis points (bps) cut in the key policy rate, bringing it down to 13 percent, the lowest level since April 2022.
Since June, the MPC has pursued a monetary easing strategy in response to moderating inflation. With this latest cut, the policy rate has been reduced by a cumulative 900 bps over the past six months across five successive meetings. The current 13 percent policy rate has reached two-and half-year lowest level as previously its was 12.25 percent in April 2022.
The meeting of the MPC was held on Monday and chaired by the Governor SBP Jameel Ahmed to review the key economic indicators and take a decision on policy rate.
During the meeting MPC expressed inflation statistics and observed that headline inflation eased further to 4.9 percent y/y in November from 7.2 percent in the previous month in line with the MPC’s expectations. Committee noted that this deceleration was mainly driven by continued decline in food inflation as well as the phasing out of the impact of the hike in gas tariffs in November 2023.
The sharp decline in inflation was mainly driven by a favorable base effect from gas prices, along with the continued moderation in food inflation and benign global commodity prices. The Committee noted that these factors are likely to continue in the near term and may bring headline inflation even lower in the coming months.
The decision MPC’s decision also reflecting its confidence in the effectiveness of ongoing monetary policy measures. With positive developments on the economic front, the Committee also assessed that the impact of the cumulative reduction in the policy rate from June 2024 is beginning to unfold and will continue to materialize over the next few quarters. In this context and taking into account recent decision, the Committee noted that the real policy rate remains appropriately positive to stabilize inflation within the target range of 5-7 percent.
The Committee noted that core inflation, at 9.7 percent, is proving to be sticky, whereas inflation expectations of consumers and businesses remain volatile. To this effect, the Committee reiterated its previous assessment that inflation may remain volatile in the near term before stabilizing in the target range. At the same time, the growth prospects have somewhat improved, as reflected by the recent uptick in high-frequency indicators of economic activity.
Overall, the Committee assessed that its approach of measured policy rate cuts is keeping inflationary and external account pressures in check, while supporting economic growth on a sustainable basis.
Accordingly, the Committee assessed FY25 inflation to average substantially below its earlier forecast range of 11.5-13.5 percent. Meanwhile, it was observed that core inflation declined marginally in November, while consumers’ inflation expectations inched up further.
At the same time, the inflation outlook is susceptible to multiple risks, including additional measures to meet the revenue shortfall, resurgence in food inflation and an increase in global commodity prices. Notwithstanding these risks and the expected phase out of the favorable base effect, the Committee, on balance, viewed that the monetary policy stance remains appropriate to stabilize inflation in its target range.
The Committee also noted the key developments since its last meeting that may have implications for the macroeconomic outlook. First, surplus the current account, which, amidst weak financial inflows and substantial official debt repayments, helped increase the SBP’s FX reserves to around $12 billion.
Second, global commodity prices remained generally favorable, with positive spillovers on domestic inflation and the import bill. Third, credit to the private sector recorded a noticeable increase, broadly reflecting the impact of ease in financial conditions and banks’ efforts to meet the advances-to-deposit ratio (ADR) thresholds. Lastly, the shortfall in tax revenues from the target has widened.
According to the Monetary Policy Statement incoming economic data indicates improved prospects for economic growth. In the agriculture sector, downside risks to the overall crop outlook have somewhat subsided, while activity in the industrial sector is gaining further traction. Key large-scale manufacturing sectors are already depicting strong growth till Q1FY25.
Moreover, the latest high-frequency indicators such as domestic sales of cement, auto, fertilizer and POL products suggest that this momentum in industrial activity is continuing. Going forward, improving business confidence and easing financial conditions are expected to support economic growth. Considering these developments, the MPC expects the real GDP growth in FY25 to remain in the upper half of the projected range of 2.5-3.5 percent.
On the external sector side, the current account posted a surplus of $0.2 billion during July-October FY25, driven by robust workers’ remittances and strong export performance. Exports grew by 8.7 percent, mainly driven by HVA textile, rice and POL exports.
At the same time, favorable global commodity prices helped contain the import bill despite a sizeable increase in import volumes. The surplus in the current account, along with the improved foreign investment inflows, helped build up SBP’s FX reserves, despite weak official inflows.
Going forward, sustained uptrend in workers’ remittances and exports, along with favorable international commodity prices, are expected to keep the current account deficit near the lower bound of the projected 0-1 percent of GDP range in FY25. This will enable the SBP’s FX reserves to exceed $13.0 billion by June 2025.
SBP mentioned that the revised data for fiscal operations showed improvement in both the overall and primary balances during the first quarter of FY25. FBR revenues grew by 23 percent YoY during July-November FY25, however, substantially lower than the required growth to achieve the annual tax collection target.
On the expenditure side, the declining yields will lead to a sizeable saving in interest payments on domestic debt compared to the budget estimates. These lower interest payments will help the government to contain the fiscal deficit; however, achieving the targeted primary surplus would be challenging. In this regard, considerable efforts and additional measures would be required to meet the annual revenue target. This highlights the importance of fiscal reforms to broaden the tax base to achieve the targeted fiscal consolidation.
According to the SBP, the broad money (M2) growth decelerated to 13.9 percent y/y at end-November from 15.2 percent at the time of the last MPC meeting. This deceleration primarily stemmed from NDA of the banking system due to a decline in government borrowing, while the contribution of NFA in overall M2 growth increased.
Banks’ lending to the private sector and non-bank financial institutions accelerated amidst easing financial conditions and their efforts to comply with minimum ADR thresholds by end-December 2024. Credit to private sector businesses increased substantially, with consumer financing also recording a noticeable rise in October 2024. On the liability side, deposits remained the mainstay in M2 growth, though the currency-to-deposit ratio increased slightly.
Reuters adds: “Inflation may remain volatile in the near term before stabilizing in the target range,” the bank said.
During a call with analysts, the central bank chief, Jameel Ahmad, said that the State Bank of Pakistan (SBP) did not target any particular real interest rate level when making its policy rate decision on Monday.
However, he said in the past the central bank had targeted 5-7% inflation in the medium term, and this target was now in sight within the next 12 months.
The South Asian country is navigating a challenging economic recovery path and has been buttressed by a $7 billion facility from the International Monetary Fund (IMF) in September.
The bank noted that “considerable efforts and additional measures” would be required for Pakistan to meet its annual revenue target, a key focus of the IMF agreement.
All 12 analysts surveyed by Reuters had expected a 200 bps cut, after inflation fell sharply, slowing to 4.9% in November, largely due to a high base a year earlier, coming in below the government’s forecast and significantly lower than a multi-decade high of around 40% in May last year.
“The cut supports economic growth, evident from improved industrial activity and credit expansion. However, sticky core inflation and revenue shortfalls remain key risks to watch,” said Tahir Abbas, head of equities and research at Arif Habib Limited.
Copyright Business Recorder, 2024