The State Bank of Pakistan (SBP) has announced a 250 basis point (bps) cut in the key interest rate, bringing it down to 15%. This marks the fourth consecutive rate cut in as many months, reflecting the central bank’s strategic response to the sharp deceleration in inflation and other favorable economic developments. With this latest adjustment, the SBP has reduced the policy rate by a cumulative 700 bps over recent monetary policy reviews, as it seeks to support economic growth while keeping inflation in check.
The decision, announced by the SBP following a meeting of its Monetary Policy Committee (MPC), was driven by significant reductions in inflation. Inflation is nearing the SBP’s medium-term target, supported by stable food prices, favorable global oil prices, and the absence of anticipated adjustments in gas tariffs and Petroleum Development Levy (PDL) rates. The MPC assessed these trends and determined that the current tight policy stance has been instrumental in achieving a consistent decline in inflation.
The MPC identified several recent developments impacting the country’s economic outlook. Firstly, Pakistan’s new Extended Fund Facility (EFF) program with the International Monetary Fund (IMF) has reduced economic uncertainty and strengthened prospects for external funding. Additionally, surveys conducted in October show improved confidence and lower inflation expectations among both consumers and businesses. The secondary market has seen a reduction in yields on government securities, and the Karachi Interbank Offered Rate (KIBOR) has declined. Furthermore, while tax revenues fell short of targets, favorable economic trends and remittances contributed to a stable external sector.
Real Sector Developments
Data from recent months indicates a gradual improvement in economic activity. Estimates for major Kharif crops have exceeded earlier expectations, with notable increases in rice and sugarcane production offsetting lower maize and cotton output. Industrial activity is also gaining momentum, particularly in the textile, food, and automobile sectors, which recorded growth during July-August 2024. These indicators, along with rising imports of raw materials and machinery, suggest strengthening business confidence and increased economic activity.
Given the easing inflationary pressures and the uptick in industrial performance, the MPC now expects real GDP growth for the fiscal year 2024-25 (FY25) to range between 2.5% and 3.5%, surpassing previous forecasts.
External Sector Stability
The external sector posted a current account surplus for the second consecutive month in September 2024, narrowing the quarterly deficit to $98 million for Q1-FY25. While imports have risen, robust remittance inflows and increased exports have helped maintain external balance. The first tranche of funds under the IMF program contributed to the SBP’s foreign exchange reserves, which reached $11.2 billion as of October 25, 2024.
Looking ahead, the MPC expects the current account deficit to remain manageable, between 0% and 1% of GDP, owing to stable remittances and export growth. Foreign exchange reserves are projected to reach approximately $13 billion by June 2025, contingent on the realization of planned official inflows.
Fiscal Sector Developments
In the fiscal arena, both the fiscal and primary balances recorded surpluses in Q1-FY25, primarily driven by record high SBP profits that boosted non-tax revenues. However, tax revenue collections fell below target for the first four months of the fiscal year. With interest payments on the decline, the government has achieved greater fiscal flexibility, though meeting primary balance targets remains a challenge. The MPC emphasized the need for fiscal reforms, including an expanded tax base and reduced losses from public sector enterprises (PSEs), to support economic stability.
Monetary and Credit Conditions
Monetary growth (M2) increased by 15.2% year-on-year as of October 25, largely due to shifts in government borrowing patterns. Government borrowing from banks has declined, creating additional liquidity for the private sector. In response, banks are expected to extend credit to avoid tax penalties associated with low Advances-to-Deposit Ratios (ADR). Additionally, SBP’s open market operations have reduced, reflecting a decrease in outstanding liquidity injections.
Inflation and Future Outlook
Inflation has shown a steady decline since August, dropping from 9.6% to 6.9% in September and further to 7.2% in October. Favorable domestic food supplies, stable global oil prices, and a positive base effect have accelerated this trend. With these factors in place, the MPC anticipates that inflation will continue to decrease in the coming months, with FY25’s average inflation rate now projected to fall below the previously estimated 11.5%-13.5%.
Nevertheless, the committee acknowledged potential risks, including geopolitical instability, fluctuating food prices, and unforeseen tax measures that could impact inflation. The SBP reaffirmed its commitment to maintaining price stability and supporting sustainable economic growth within the 5%-7% inflation target range.
The SBP’s policy rate cut aligns with broader economic improvement indicators, suggesting a cautiously optimistic outlook for Pakistan’s economic recovery. With inflation easing and favorable external conditions, the MPC’s recent actions aim to strike a balance between fostering economic growth and maintaining macroeconomic stability.