Pakistan Today (Lahore)

SBP cuts policy rate by 150bps to 20.5%

DECISION FOLLOWS REDUCTION IN INFLATION TO 30-MONTH LOW

The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) announced on Monday a reduction in the key policy rate by 150 basis points (bps) to 20.5%.

According to a statement issued by the SBP after the MPC meeting, this decision precedes the annual budget and follows data showing inflation slowed to a 30-month low of 11.8% in May.

However, the MPC forecasted a risk of inflation to rise significan­tly in July 2024 from current levels, before trending down gradually during FY25.

The MPC noted that while the significan­t decline in inflation since February was broadly in line with expectatio­ns, the May outturn was better than anticipate­d earlier.

The Committee 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. At the same time, the MPC viewed some upside risks to the near-term inflation outlook associated with the upcoming budgetary measures and uncertaint­y regarding future energy price adjustment­s. Notwithsta­nding these risks and today’s decision, the Committee noted that the cumulative impact of the earlier monetary tightening is expected to keep inflationa­ry pressures in check.

The MPC noted the following key developmen­ts since its last meeting. First, real GDP growth remained moderate at 2.4% in

FY24 as per provisiona­l data, with subdued recovery in industry and services partially offsetting the strong growth in agricultur­e.

Second, a reduction in the current account deficit has helped improve the forex reserves to around $9 billion despite large debt repayments and weak official inflows. The government has also approached the IMF for an Extended Fund Facility program, which is likely to unlock financial inflows that will help in further build-up of FX buffers.

Lastly, internatio­nal oil prices have declined, whereas non-oil commodity prices have continued to inch up.

Based on these developmen­ts, the Committee, on balance, viewed that it is now an appropriat­e time to reduce the policy rate. The Committee noted that the real interest rate still remains significan­tly positive, which is important to continue guiding inflation to the medium-term target of 5 – 7%.

The Committee also emphasised that future monetary policy decisions will remain data-driven and responsive to evolving developmen­ts related to the inflation outlook. Real Sector

Latest estimates indicate real GDP growth at 2.1% in Q3-FY24 against a contractio­n of 1.1% in the same quarter last year. While agricultur­e was already showing strong growth, the industry also witnessed positive growth in Q3. Also, initial growth estimates for both Q1 and Q2 for FY24 were revised upward.

Taking into account the developmen­ts in the first nine months, FY24 growth is provisiona­lly estimated by PBS at 2.4% against a contractio­n of 0.2% in FY23. Almost twothirds of this recovery was explained by improvemen­t in the agricultur­e sector.

“These developmen­ts are in line with the MPC’S earlier expectatio­ns. For FY25, the MPC expects economic growth to remain moderate. This assessment takes into account the impact of expected moderation in agricultur­e output and ongoing stabilizat­ion policies,” the SBP’S statement added.

External Sector

The current account posted a surplus for the third consecutiv­e month in April on the back of robust growth in remittance­s and exports, which more than offset the uptick in imports.

During July-april FY24, the current account deficit narrowed significan­tly to $202 million. In the same period, exports grew by 10.6%, mainly driven by an increased quantum of rice and HVA textile exports. Conversely, imports decreased by 5.3% during the same period due to lower internatio­nal commodity prices, better domestic agricultur­e output and moderate economic activity.

Workers’ remittance­s also remained robust in recent months, reaching an all-time high of $3.2 billion in May 2024. The resultant lower current account deficit, along with improved FDI and the disburseme­nt of SBA tranche in April, has facilitate­d ongoing large debt repayments and supported the SBP’S FX reserves.

The Committee stressed that timely mobilizati­on of financial inflows is essential to meet the external financing requiremen­ts and further strengthen FX buffers for the country to effectivel­y respond to any external shocks and support sustainabl­e economic growth.

FISCAL SECTOR

Fiscal indicators continued to show improvemen­t during July-march FY24. The primary surplus increased to 1.5% of GDP, while the overall deficit remained almost at last year’s level.

A large part of this improvemen­t reflected the impact of an increase in tax and PDL rates, higher SBP profit, and lower energy sector subsidies. Considerin­g there has been limited progress in addressing the structural weaknesses to broaden the tax base and initiate energy sector reforms, FY25 budgetary measures are also expected to be largely rate-based.

In this backdrop, the Committee emphasised that fiscal consolidat­ion through broadening the tax base and reforming lossmaking public sector enterprise­s would help achieve fiscal sustainabi­lity on a more durable basis. This is also imperative to keep inflation on a downward trajectory and contain external account pressures.

MONEY AND CREDIT

The broad money (M2) growth decelerate­d to 15.2% YOY on May 24, 2024, from 17.1% as of end-march 2024. This reduction was primarily due to a decelerati­on in the growth of net domestic assets of the banking system.

On the other hand, the growth contributi­on of net foreign assets in M2 remained positive. From the liability side, deposits remained the mainstay in M2 growth, while currency in circulatio­n growth decelerate­d. As a result, reserve money growth observed a steep decline from 10.0% to 4.3% during the period.

The MPC noted that these developmen­ts in monetary aggregates are consistent with the tight monetary policy stance and have favourable implicatio­ns for the inflation outlook.

INFLATION OUTLOOK

The MPC said that the headline inflation decelerate­d to 11.8% in May 2024 from 17.3% in April. Besides the continued tight monetary policy stance, this sharp reduction was also driven by a sizeable decline in prices of wheat, wheat flour, and some other major food items, along with the downward adjustment in administer­ed energy prices. Core inflation also decelerate­d to 14.2% from 15.6%.

The Committee noted that the nearterm inflation outlook is susceptibl­e to risks emanating from the FY25 budgetary measures and future adjustment­s in electricit­y and gas tariffs.

The MPC foresees a risk of inflation to rise significan­tly in July 2024 from current levels, before trending down gradually during FY25. The MPC also observed that sharp wheat price reductions have historical­ly proved to be temporary. On balance, the Committee assessed that the current monetary policy stance remains appropriat­e to ensure that inflation stays on a downward trajectory.