SBP cuts key policy rate by 100 basis points, takes it to 19.5%

SBP reduces interest rate to 19.5% amid decline in the inflation

July 29, 2024 05:06 PM

The State Bank of Pakistan (SBP) has announced a one percent reduction in the interest rate, bringing it down to 19.5 percent from 20.5% amid the decline in the inflation rate, reported 24NewsHD TV channel.

Addressing a press conference in Karachi SBP Governor Jameel Ahmad said “We have noted that the inflation is on a declining trend."

Ahmad stated that inflation is gradually decreasing, and the country's economy is on a path to recovery.

Consequently, the monetary policy committee decided to reduce the interest rate by 100 basis points, lowering it to 19.5 percent, he added.

The decision comes as a measure to support economic growth, with the central bank optimistic about further improvements in economic indicators.

"The reduction in the interest rate reflects our confidence in the current economic trajectory," he said.

He said that future projections expect the average inflation rate to stabilize between 23% and 25%, following last year's 23.4%.

Jameel Ahmad said the central bank’s MPC had met earlier today and reviewed the current economic developments, highlighting the key role of declining inflationary pressure in the decision. He noted that inflation had declined from a record-high of 38pc in May 2023 to 12.6pc in June 2024.

Furthermore, the MPC statement said that the committee had observed that the June 2024 inflation was slightly better than anticipated, adding that it also assessed that the inflationary impact of the fiscal year 2025 budgetary measures was broadly in line with earlier expectations.

It also noted that the external account has continued to improve, as reflected in SBP’s foreign exchange reserves “despite substantial repayments of debt and other obligations”.

Due to these reasons, the committee “viewed that there was room to further reduce the policy rate in a calibrated manner to support economic activity while keeping inflationary pressures in check”.

On positive developments, the statement said that the current account deficit had narrowed in the fiscal year 2024 and SBP’s FX reserves had “improved significantly from $4.4 billion at end-June 2023 to above $9.0 billion”.

Furthermore, it highlighted that the country had reached a staff-level agreement with the International Monetary Fund (IMF) for a 3-year extended fund facility programme of $7bn.

Previously, the headline inflation for June clocked in at 12.6pc on year-on-year, according to data from the Pakistan Bureau of Statistics (PBS).

Earlier in June, Pakistan's central bank had cut its key policy rate for the first time in four years, lowering it by 1.5 percentage points to 20.5% due to a significant slowdown in inflation, which dropped to 11.8% in May from a high of 38% in May 2023.

A reduction in the current account deficit was also reported, with the deficit decreasing to $700 million in the last fiscal year. Foreign exchange reserves saw a significant increase, rising by $5 billion to reach $9.4 billion by June 2024.

Governor Ahmad announced the removal of all import restrictions, facilitating seamless external payments. Despite a monthly increase of $1.3 billion in imports, reserves have remained stable. Banks have resumed dividend payments to foreign investors, transferring $2.2 billion in profits abroad, marking a sevenfold increase in profit repatriation.

Improvements were noted in payments for airline royalties and technical fees. The SBP has made it easier for importers to conduct transactions through their banks without needing prior central bank approval.

The oil import bill has decreased significantly, dropping from $2.3 billion to $1.4 billion in the first quarter due to lower international prices and reduced volumes. This reduction has provided substantial support. Non-oil imports stood at $3.2 billion, reflecting an increase of over $1 billion.

For the current fiscal year, GDP growth is projected to be between 2.5% and 3.5%.

Real Sector

Latest high-frequency indicators continue to reflect moderate economic activity. Auto and POL (excluding FO) sales and fertilizer offtake increased on m/m basis in June. Large-scale manufacturing also recorded a sharp improvement in May 2024, mainly driven by the apparel sector. The growth in the 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 percent of GDP from 1.0 percent in the preceding year. This, along with the revival of financial inflows, helped build the SBP’s FX reserves.

Looking ahead, the MPC anticipated 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.

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 about 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 percent 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 percent and 2.6 percent, 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 percent at end-June 2023 to 33.6 percent 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

The MPC said that headline inflation rose to 12.6 percent YoY in June 2024 from 11.8 percent in May. This increase was primarily driven by higher electricity tariffs and Eid-related increases in prices, which were partly offset by the downward adjustments in domestic fuel prices.

Meanwhile, core inflation 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 – 13.5 percent in FY25, down significantly from 23.4 percent in FY24, it added.