Pakistan: SBP reduces policy rate by 100bps

At its meeting today, the Monetary Policy Committee (MPC) of State Bank of Pakistan (SBP) decided to cut the policy rate by 100 basis points to 19.5%, effective from July 30, 2024.

The Committee 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 external account has continued to improve, as reflected by the build-up in foreign exchange reserves held by SBP despite substantial repayments of debt and other obligations.

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

The Committee noted the following key developments since its last meeting:

First, the current account deficit narrowed sharply in FY24 and forex reserves of SBP reserves improved significantly from US$4.4 billion at end June 2023 to above US$9.0 billion.

Second, the country reached a staff level agreement with the IMF for a 37-month EFF program of about US$7.0 billion.

Third, sentiment surveys conducted in July showed a worsening in inflation expectations and confidence of both consumers and businesses.

Fourth, international oil prices have remained volatile in recent weeks, whereas prices of metals and food items have eased.

Lastly, with the ease in inflationary pressures and labour market conditions, central banks in advanced economies have also started to cut their policy rates.

Taking stock of these developments, the Committee assessed that, despite today’s decision, the monetary policy stance remains adequately tight to guide inflation towards the medium-term target of 5 to 7 percent. This assessment is also contingent on achieving the targeted fiscal consolidation, timely realization of planned external inflows and addressing underlying weaknesses in the economy through structural reforms.

Real Sector

Latest high-frequency indicators continue to reflect moderate economic activity. Auto and POL (excluding FO) sales and fertilizer offtake increased on MoM basis in June.

Large-scale manufacturing also recorded a sharp improvement in May 2024, mainly driven by the apparel sector.

The growth in agriculture sector, after showing a strong performance in FY24, is expected to slow down in this fiscal year.

Latest satellite images and input conditions for Kharif crops also support this assessment. However, activity in the industry and services sectors is expected to recover, supported by relatively lower interest rates and higher budgeted development spending.

Based on this, the MPC assessed FY25 real GDP growth in the range of 2.5 to 3.5 percent as compared to 2.4 percent recorded last year.

External Sector

After recording surpluses for three consecutive months, the current account posted a deficit in May and June, in line with the MPC’s expectation. These deficits were largely due to higher dividend and profit payments and a seasonal increase in imports, which more than offset a significant increase in exports and workers’ remittances.

Cumulatively, the current account deficit in FY24 narrowed significantly to 0.2% of GDP from 1.0% in the preceding year. This, along with the revival of financial inflows, helped build the SBP’s FX reserves. Looking ahead, the MPC expects a modest increase in imports, in line with the growth outlook.

At the same time, the continued robust growth in workers’ remittances, along with an increase in exports, is expected to contain the current account deficit in the range of 0 - 1.0 percent of GDP in FY25.

The Committee assessed that the expected financial inflows, including planned official flows under the IMF program, would help finance this current account deficit and further strengthen the FX buffers.

Fiscal Sector

The government’s revised estimates indicate improvement in fiscal balances during FY24, as the primary balance turned into a surplus and the overall deficit declined from last year. However, amidst a shortfall in budgeted external and non-bank financing, the government’s reliance on the domestic banking system increased significantly.

The Committee expressed concern on increasing reliance on banks for deficit financing, which has been squeezing borrowing space for the private sector. For FY25, the government has set the primary surplus target at 2.0% of GDP.

The MPC emphasized on achieving the envisaged fiscal consolidation and timely realization of planned external inflows to support overall macroeconomic stability, and build fiscal and external buffers for the country to respond to future economic shocks.

Money and Credit

The MPC noted that the trends and composition of monetary aggregates during FY24 remained consistent with the tight monetary policy stance. Broad money (M2) and reserve money grew by 16.0% and 2.6%, respectively, well below the growth in nominal GDP.

Almost the entire growth in M2 was led by bank deposits, while currency in circulation remained almost at last year’s level. As a result, the currency to deposit ratio improved, as it declined from 41.1% at end June 2023 to 33.6% at end June 2024. At the same time, the improvement in external account increased the contribution of net foreign assets in monetary expansion.

Meanwhile, the growth in net domestic assets of the banking system decelerated amidst subdued demand for private sector credit. The Committee viewed these developments as favorable for the inflation outlook.

Inflation Outlook

As expected, headline inflation rose to 12.6%YoY in June 2024 from 11.8% in May. This 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.

Core inflation, meanwhile, has steadied around 14 percent over the past two months. 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 to 13.5 percent in FY25, down significantly from 23.4 percent in FY24.

Pakistan must take cue from China

State Bank of Pakistan (SBP) is scheduled to announce its policy rate today (Monday, August 22, 2022). While some of the analysts are demanding a reduction in the interest rate, others fear the central bank may increase the rate. 

If the newly appointed SBP Governor, Jameel Ahmed, is serous in accelerating Pakistan’s GDP growth rate, he must reduce interest rate. Let me reiterate once again that Pakistan suffers from cost-pushed inflation. Therefore, reduction in interest rate is a must for easing inflation.

The SBP Monetary Policy Committee must take a cue from China. It has reduced benchmark lending rates on today, adding to easing measures announced last week. This is one of the signs that Beijing is stepping up efforts to spur credit demand in an economy hobble by a property crisis and a resurgence of COVID infections.

The one-year loan prime rate (LPR) was lowered by 5 basis points to 3.65% at the central bank's monthly fixing, while the five-year LPR was slashed by a bigger margin of 15 basis points to 4.30%.

In a Reuters poll conducted last week, 25 out of 30 respondents predicted a 10-basis-point reduction to the one-year LPR. All of those in the poll also projected a cut to the five-year tenor, including 90% of them forecasting a reduction larger than 10 bps.

Most new and outstanding loans in China are based on the one-year LPR, which is now loosely pegged to the central bank's medium-term lending facility (MLF) rate, while the five-year rate influences the pricing of mortgages.

 

State Bank of Pakistan should reduce interest rate

State Bank of Pakistan (SBP) is scheduled to announce its Monetary Policy Statement on this Saturday (April 9th). While analysts are making all sorts of speculations certain quarters insist that SBP should reduce interest rate by 50 basis points at least. This demand is being raised after Reserve Bank of India (RBI) announced to cut the benchmark repurchase rate to 6.5 percent from 6.75 percent, the lowest since March 2011. This decision has been made despite many odds only to creating more room to face the upcoming challenges.

The options, in terms of priority, being talked about in Pakistan are: 1) maintaining status quo, 2) an increase and 3) a reduction. Some analysts fear that most probably the newly constituted Policy Board may opt for increasing the rate by bowing down before the IMF pressure. The effort will be to avoid any criticism by the lender of last resort, which is yet to release the last tranche. Keeping the IMF happy is most important because the incumbent government will have to enter into another agreement to meet its debt serving obligations.

To be honest I am fascinated by the decision of RBI chief of reducing the rate, though it may be termed notional. The logic being offered is simple, accelerating the GDP growth rate. He is not following any rocket science but the footsteps of many central banks, even the US Fed is not convinced about the interest rate hike.

The chief stated categorically that the stance of monetary policy would remain accommodative and RBI would continue to watch macroeconomic and financial developments with a view to respond with further policy action as space opens up. The present RBI chief has cut rate five times since January 2015. His option for further easing is limited due to the risk of a third straight year of below average rainfall.

It is true that pressure from the IMF is mounting on Pakistan for missing some key targets and the country may face even more stringent conditions under the new arrangements. However, the incumbent government has to come up with some home grown solutions rather than following IMF recipe blindly. This demands reduction in interest rate to facilitate fresh investment, creation of new jobs and above all improving Pakistan’s competitiveness in the global markets. The cost of doing business has to be brought down.

The cost of doing has to be brought down by reducing interest rate, bringing down electricity and gas tariffs and above all coming up with ‘business friendly policies’. The incumbent government has been enhancing tax on everything rather than catching tax evaders. Energy crisis is the outcome of blatant pilferage and non-payment of bills by certain groups.

Pakistan’s economy is plunging deeper into crisis and needs ‘out of box policies’. The focus must shift from collecting revenue to creation of new production facilities and jobs. Following the IMF recipe will not bring the country out of vicious circle of borrowing. The pace of economic activities has to be accelerated by bringing down cost of doing business and reduction in interest rate is the first step.