KARACHI: The State Bank of Pakistan (SBP) on Monday maintained the key policy rate at 15 per cent, owing to deceleration in the economic activity and an ease in the headline inflation.

The Monetary Policy Committee (MPC) noted that the recent floods have altered the macroeconomic outlook and a fuller assessment of their impact is underway.

Based on currently available information, the MPC was of the view that the existing monetary policy stance strikes an appropriate balance between managing inflation and maintaining growth in the wake of the floods.

On the one hand, inflation could be higher and more persistent due to the supply shock to food prices, and it is important to ensure that this additional impetus does not spillover into broader prices in the economy.

On the other, the growth prospects have weakened, which should reduce demand-side pressures and suppress underlying inflation.

In light of these offsetting considerations, the MPC considered it prudent to leave monetary policy settings unchanged at this stage.

Since the last meeting, the committee noted that the desired moderation in the economic activity has become more visible and entrenched, signaling that the tightening measures implemented over the last year are gaining traction.

With growth likely to slow further in the aftermath of the floods, this tightening will need to be carefully calibrated going forward.

The headline inflation fell last month after peaking in August as expected, due to an administrative cut in the electricity prices. However, the core inflation continued to drift upwards in both rural and urban areas.

The current account and trade deficits narrowed significantly in August and September, respectively, and the rupee has recouped some of its losses following the recent depreciation.

The combined 7th and 8th review under the on-going International Monetary Fund (IMF) programme was successfully completed on August 29, releasing a tranche of $1.2 billion.

The MPC discussed the post-flood macroeconomic outlook, noting that projections are still preliminary and would become firmer after the flood damage assessment being conducted by the government is finalised.

Based on the currently available information, the GDP growth could fall to around 2 per cent in fiscal year 2023, compared with the previous forecast of 3 per cent 4 per cent before the floods.

Meanwhile, higher food prices could raise average headline inflation in fiscal year 2023 somewhat above the pre-flood projection of 18per cent to 20 per cent.

The impact on the current account deficit is likely to be muted, with pressures from higher food and cotton imports and lower textile exports largely offset by slower domestic demand and lower global commodity prices.

As a result, any deterioration in the current account deficit is expected to be contained, still leaving it in the vicinity of the previously forecast 3 per cent of the GDP.

The economy has slowed considerably since the last MPC meeting. Most demand indicators were lower in both July and August than in the same period last year, including sales of cement, petroleum products and automobiles.

On the supply side, electricity generation declined for the third consecutive month in August, falling by 12.6 per cent on a year-on-year basis.

In July, the large scale manufacturing (LSM) declined 1.4 per cent year-on-year, its first contraction in two years, largely driven by broad-based deterioration in the domestically-oriented sectors.

Looking ahead, the recent floods are likely to adversely affect the output of cotton and rice as well as the livestock sector this year.

The current account deficit shrank for the second consecutive month in August to only $0.7 billion, almost half the level in July.

In September, the Pakistan Bureau of Statistics (PBS) data shows that the trade deficit contracted sharply 19.7 per cent on a monthly basis and 30.6 per cent on a yearly basis to reach $2.9 billion, reflecting a decline in both energy and non-energy imports amid stable exports.

During the first quarter of fiscal year 2023, imports have declined 12.7 per cent to $18.7 billion while exports have grown by 1.8 per cent to $7 billion.

Looking ahead, the floods are likely to result in greater need for some agricultural imports such as cotton and a few perishable food items.

The rice and textiles exports are likely to be negatively affected. However, these adverse impacts could, to a large extent, be offset by downward pressures on the import bill from lower domestic growth and falling global commodity prices and shipping costs.

Additionally, the impact on the current account could be further cushioned by international assistance in the form of current transfers as experienced after previous natural disasters in Pakistan.

Given secured external financing and additional commitments in the wake of the floods, the foreign exchange reserves should improve through the course of the year.

In July, fiscal outcomes were better than in the same period last year. The fiscal deficit fell to 0.3 per cent of the GDP while the primary balance recorded a surplus of 0.2 per cent of the GDP.

This improvement was largely due to higher Federal Board of Revenue (FBR) tax revenues as well as a decline in the government spending. During the first quarter, the FBR tax collection rose to Rs1.625 trillion, surpassing the target by Rs27 billion.

While the floods could make it challenging to achieve the planned fiscal consolidation this year, the government has so far been able to meet urgent spending needs through re-allocation and re-appropriations of budgeted funds.

Looking ahead, additional foreign inflows, including in the form of grants, should help fund any fiscal slippages.

Beyond the current year, reconstruction and rehabilitation will necessitate additional spending over the medium-term, with assistance from the international community.

The private sector credit has seen a net retirement of Rs0.7 billion so far this fiscal year, compared with an expansion of Rs62.6 billion during the same period last year.

This decline in credit mainly reflects a retirement of working capital loans and a sharp fall in the consumer finance.

The headline inflation fell more than 4 percentage points in September to 23.2 per cent after peaking in August, driven by a reduction in the electricity prices due to an administrative intervention.

At the same time, the momentum of inflation also slowed by more than expected, declining by 1.2 per cent on a month-on-month basis.

Both core and food inflation picked up further. Looking ahead, the supply-shock to food prices from the floods is expected to put additional pressure on headline inflation in the coming months.

The headline inflation is still projected to gradually decline through the rest of the fiscal year, particularly in the second half. Subsequently, it should fall towards the upper range of the 5 per cent to 7 per cent medium-term target by the end of fiscal year 2024.

A continuation of prudent monetary policy and orderly movements in the rupee should help contain core inflation going forward. At the same time, curbing food inflation through administrative measures to resolve supply-chain bottlenecks and any necessary imports should be a high priority.

The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth.

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