The Monetary Policy Committee (MPC), met under the chairmanship of the Governor State Bank of Pakistan (SBP) on 10 March 2025, and decided to keep the policy rate unchanged at 12 percent, justifying this decision on the grounds that core inflation at 7.8 percent remained “at an elevated level and is proving stickier than anticipated.” This observation was in spite of core inflation declining from 13.1 percent in April 2024 to 7.8 percent in February 2025 - a nearly 41 percent decline, with the policy rate decline from 22 percent to 12 percent (a decline of 45 percent).
Since July 2024 core inflation began to overtake Consumer Price Index (CPI) with a widening differential largely attributable to the fact that core inflation does not include price volatile items like energy and food but does include the impact of prices on incomes which have stagnated in the private sector for the past three to four years (though government employees’ income has increased significantly each year at the taxpayers’ expense accounting for about 7 percent of the country’s total workforce).
The stickiness displayed by core inflation could therefore be indicative of the decline in the purchasing power of the average Pakistani employed in the private sector.
The Monetary Policy Statement (MPS) further contended that “inflation outlook, however is susceptible to risks emanating from volatility to food prices, timing, and magnitude of energy price adjustments, additional revenue measures, protectionist policies in major economies and uncertain outlook of global commodity price.” Or, in other words, the susceptibility to risks is emanating from domestic factors that impact on CPI and not core inflation – items whose prices require approval of the International Monetary Fund (IMF) staff under the ongoing programme with the aim to achieve full cost recovery for the poorly run power sector and heavy reliance on petroleum levy (an input for transporting goods from farm to market) as a revenue source (budgeted at a whopping 1.26 trillion rupees this year).
Be that as it may, any change in the policy rate is determined by the need to have a positive real rate of return: the difference between the discount rate and inflation. In October 2024 the IMF team uploaded the documents relating to Pakistan’s request from the IMF for an extended arrangement under the extended fund facility the staff stated that “the recent decrease (referring to the MPC’s 13 September 2024 decision to cut the rate to 17.5 percent) was appropriate and consistent with a tight monetary policy stance.” The headline inflation that month was 6.9 percent and core inflation was 9.3 percent.
The discount rate was 10.6 percent higher than headline inflation and 8.2 percent higher than core inflation.
At present, the discount rate is 10.5 percent higher than CPI and only 4.2 percent higher than core inflation, indicating a shrinking of the disparity between the discount rate and core inflation from 8.2 to 4.2 percent.
The Fund report stipulates that “Going forward, the SBP should remain vigilant as its fight against inflation is approaching the “last mile” and any further lowering of the policy rate must be predicated on evidence that core inflation is moderating, and inflation expectations have re-anchored.” While inflation data suggests precisely that which should have led to a rate decline, one would assume that other factors led the Fund team to stay MPCs hand.
The MPC met a couple of days after the IMF team’s visit to SBP headquarters where, reportedly, it engaged with many SBP officials rather than with a select few as was customary in the past, which would lead many to conclude that the decision to keep the rate unchanged at 12 percent was perhaps prompted by the Fund team. Three observations gleaned from the IMF October 2024 documents would clarify why the rate was not reduced, as was the general perception.
First, “monetary policy should remain geared towards reducing inflation towards the SBP target.” In all the MPSs in 2024 as well as in the current year, inflation was projected at 5 to 7 percent. Last month headline inflation was estimated at 1.5 percent while core inflation was 7.8 percent – the former 3.5 percent below target and the latter a mere 0.8 percent above target yet the reason for the discount rate remaining unchanged indicates that in spite of the government meeting most of the key Fund conditions, the prospect of further upward energy price adjustments (as costs continue to rise in spite of claims to the contrary) coupled with the need to generate additional revenue measures (a shortfall of 601 billion rupees has been acknowledged in the first seven months of the year) remains.
Second, growth estimates are now down to 2.5 percent (instead of the budgeted 3.5 percent) due to a severely contractionary fiscal policy - reflected by claims of major uptick in taxes collected in spite of the seven-month shortfall reaching 601 billion rupees - and Large Scale Manufacturing Sector remaining in the negative territory as per government data sources.
It is also relevant to note that questions about data integrity remain valid in this country, yet these were strengthened by the comment in IMF’s October documents: “important shortcomings remain in the source data available for sectors accounting for around a third of GDP, while there are issues of granularity and reliability of Government Finance Statistics.”
Independent economists claim that headline inflation is understated by at least 4 to 5 percentage points based on the fact that Pakistan Bureau of Statistics is taking account of the lowest heavily subsidised rate of utilities (ironically including electricity) and essential commodities rather than the average.
And finally, the Fund documents note that the Pakistani authorities “recognized the risks ahead and the need to have a cautious approach in easing monetary policy.
The authorities also took note of the complementarity between an appropriate fiscal stance and the central bank’s ability to pursue its price stability objective.“ Needless to add, the more than 40 percent budgeted rise in tax collections coupled with a 12 discount rate, a severely contractionary monetary policy especially when compared with the rates prevalent in our regional competitors even though it has been reduced by 10 percent from the rate prevailing in April 2024, bear testimony to the ongoing complementarity of fiscal and monetary policies with rate remaining unchanged.
Could the rate remaining unchanged be premised on the country’s current account? The MPS noted: “the current account turned into a deficit in January 2025; shrinking the cumulative surplus to dollar 0.7 billion during July-January FY25. While import volumes have been rising consistently in line with the pickup in economic activity, the uptick in some global commodity prices further pushed up import payments in January.
However, robust workers’ remittances, along with relatively moderate growth in exports, proved instrumental in financing the elevated imports.
The MPC assessed that these developments are broadly in line with its expectation, and reaffirmed the FY25 current account balance projection of a surplus and a deficit of 0.5 percent of GDP.“ But at the end noted that “nonetheless, net financial inflows remained weak, mainly due to a shortfall in planned official inflows,” even though the majority of debt repayments for the year have already been made.
With lower debt repayments and expected realization of planned official inflows in the remaining months of FY25, the SBP’s FX reserves are likely to reach above dollar 13 billion by June 2025.“
And yet concludes on the ominous note that “going forward, the MPC emphasized the importance of strengthening external buffers in the presence of heightened global economic uncertainty.” Pakistan is a relatively closed economy not integrated with the global economy and therefore emphasis on global economic security maybe partly seen as passing on the buck to external factors.
To conclude, the decision to keep the rate unchanged is in all likelihood to ensure the success of the IMF’s first review that would release the tranche of one billion dollars.
Copyright Business Recorder, 2025
