Key policy rate slashed by 200bps to 17.5% from 19.5%,

KARACHI: The Monetary Policy Committee (MPC) has reduced the key policy rate by 200 basis points, bringing it down to 17.5% from the previous 19.5%, the State Bank of Pakistan (SBP) announced on Thursday.

This decision follows a decline in inflation to a single-digit figure for the first time in nearly three years. The new policy rate will take effect on September 13, 2024.

According to a statement from the central bank, both headline and core inflation have sharply decreased over the last two months. The report highlighted that this disinflation has progressed faster than anticipated, primarily due to delays in raising energy prices and favorable global trends in oil and food prices.

During its meeting, the MPC acknowledged the uncertainty surrounding these developments, which called for a cautious approach to monetary policy.

It emphasized that a tight monetary policy stance has been key in reducing inflation over the past year.

The committee also highlighted several important developments since its last meeting that impact the macroeconomic outlook, such as the decline in global oil prices, the stabilization of the SBP’s foreign exchange reserves at $9.5 billion, and the noticeable decrease in secondary market yields of government securities. Business confidence improved in recent surveys, while consumer confidence showed a slight dip.

Meanwhile, the Federal Board of Revenue (FBR) tax collection for July-August 2024 fell short of its target.

Taking these factors into account, the MPC believes that the real interest rate remains sufficiently positive to bring inflation down to its medium-term target of 5% to 7%, ensuring macroeconomic stability necessary for sustainable economic growth.

In the real sector, the SBP reported a moderate increase in economic activity, with cement and petroleum sales rising by 8.5% and 6.8% respectively in August.

Business sentiment surveys supported this, showing increased capacity utilization in manufacturing.

However, the agricultural outlook weakened due to expected shortfalls in cotton production. Despite this, easing inflation and recent policy rate cuts are expected to boost growth in the industrial and services sectors, maintaining the GDP growth outlook at 2.5% to 3.5% for FY25.

In the external sector, the SBP noted strong remittance inflows and improved export earnings, which helped offset increased imports and limit the current account deficit to $0.2 billion in July 2024.

This positive trend continued into August. Favorable global economic conditions, such as lower crude oil prices, also contributed to this outcome.

Import volumes are expected to rise with domestic economic recovery, but the improvement in trade terms, particularly due to lower oil prices, should help keep the trade deficit manageable.

Stable export earnings, driven by growth in value-added textiles, are expected to balance out potential declines in rice exports.

The MPC projected the current account deficit to remain within 0% to 1% of GDP for FY25, further strengthening SBP’s foreign exchange reserves with anticipated IMF inflows.

In the fiscal sector, the SBP noted a 20.5% increase in FBR tax collections during July-August FY25, but stressed the need for faster growth in the coming months to meet annual targets.

Fiscal consolidation has played a crucial role in reducing inflation and restoring macroeconomic stability, with the gross public debt-to-GDP ratio improving from 75% at the end of June 2023 to 67.2% by June 2024.

Looking ahead, the MPC expects ongoing fiscal reforms to expand the tax base and reduce public sector enterprise losses, particularly in the energy sector, creating more room for social and development spending.

In terms of money and credit, broad money (M2) growth slowed to 14.6% as of August 2024, compared to 16.1% in June, largely due to seasonal retirements in private sector credit and commodity financing.

Reserve money growth remained below historical trends, although it showed some recovery. The MPC emphasized that official foreign exchange inflows would be vital to reducing the government’s reliance on domestic banks, improving the net foreign assets position, and freeing up resources for private sector lending.

On the inflation front, headline inflation fell to 9.6% in August 2024, the first time it has dropped below double digits in three years.

Core inflation also declined to 11.9%. The MPC attributed this decline to lower demand, improved food supplies, favorable global commodity prices, and delays in adjusting energy prices.

However, risks remain, particularly regarding the timing of energy price adjustments, global commodity price trends, and additional taxation measures to meet revenue shortfalls.

While the average inflation for FY25 could fall below the earlier forecast range of 11.5% to 13.5%, this is contingent on continued fiscal consolidation and timely external inflows.