The State Bank of Pakistan on Thursday made its third consecutive cut in its policy rate, lowering it by another 200 basis points to 17.5% for the next two months.
The latest cut brings it down to a level not seen since November 2022, demonstrating modest economic recovery. Cumulatively, the central bank has cut the policy rate by 450 basis points since June, with a 150 basis point cut followed by another 100 point cut at the end of July and the latest being a 200 point cut.
The central bank's Monetary Policy Committee (MPC) met on Thursday to review the country's economic trajectory. The committee noted that headline and core inflation had fallen sharply over the past two months, even exceeding its earlier expectations that it would remain in the 11.5% - 13.5% range for Fiscal Year 2024-2025.
The committee noted that inflation fell primarily due to a delay by the government in implementing a planned increase in administered energy prices, a comfortable foreign exchange position, arranging external financing worth $2 billion to meet International Monetary Fund (IMF) requirements for a new programme and the favourable movement in global oil and food prices. The MPC, however, noted the inherent uncertainties related to these developments had lent to a cautious monetary policy stance.
It is pertinent to note that while the 200 basis point cut was higher than the market expectation of 150 basis points, the rate remains far higher than what the market recommends, given that inflation stood at 9.64% in August 2024, the first time it has clocked in at single digits in 34 months.
The central bank's monetary policy committee underscored the importance of the tight monetary policy stance in driving the sustained decline in inflation over the past year.
However, the committee noted that core inflation remains high, and consumers' inflation expectations increased further in the latest survey. Also, uncertainty stems from the timing and magnitude of adjustments in administered energy prices, the future course of global commodity prices, and any additional taxation measures to meet the shortfall in revenue collection.
Foreign exchange reserves
The MPC noted that the country's foreign exchange reserves are around $9.5 billion for the week ending September 6.
It said that during July 2024, Pakistan received elevated workers' remittance inflows along with a substantial improvement in export earnings, which helped offset an increase in imports and contained the current account deficit to $0.2 billion.
The robust trend of workers' remittances continued in August as well.
Pakistan also received a boost from a favourable global macroeconomic environment with lower crude oil prices and a relative easing of global financial conditions.
However, the central bank expects Pakistan's import volumes to increase in the near future owing to favourable global market conditions and the ongoing domestic economic recovery. However, the improvement in the country's terms of trade, mainly driven by softening crude oil prices, is expected to contain the overall trade deficit in FY25. Also, export earnings are expected to remain stable as the growth in high-value-added textiles is expected to compensate for the likely reduction in rice exports.
The MPC observed that these factors and robust workers' remittances are expected to keep the current account deficit within the projected range of 0 – 1 percent of GDP in FY25. This contained current account deficit, along with the realisation of inflows planned under the IMF programme, will help further strengthen SBP's foreign exchange reserves. The MPC emphasised that the planned official foreign exchange inflows will be critical for the government to reduce its reliance on the domestic banking sector, improve the NFA, and create space for lending to the private sector.
Moreover, it was optimistic about the debt repayments scheduled over the next six months, given that they had ensured no lumpy repayments were to be made and all payments were spread out over the upcoming period.
Uptick in economic activity
The central bank noted that recent high-frequency sales indicators reflect a moderate pickup in economic activity. It said that domestic cement and petroleum product sales (excluding furnace oil) increased by 8.5% and 6.8% month-on-month in August, respectively.
The latest business sentiment surveys also support this assessment of a moderate pickup, as manufacturing firms have reported increased capacity utilisation during the past couple of waves. At the same time, the MPC noted that the outlook for the agriculture sector has weakened. This is attributed to an expected shortfall in cotton production from the government's target, given the decline in area under cultivation and a substantial drop in cotton arrivals by the end of August 2024.
On the other hand, the committee observed that the continued ease in inflationary pressures and the unfolding impact of recent policy rate cuts will support the growth prospects in the industry and services sectors.
The central bank expects the real GDP growth outlook to remain in line with its earlier assessment of 2.5%-3.5% for FY25.
Poor tax collection, dividends
The State Bank noted that secondary market yields of government securities have declined noticeably since the last MPC meeting.
Moreover, the government had missed its tax collection target for the first two months of the fiscal year, even though the July-August FBR tax collection had grown by 20.5%.
The MPC stressed that the pace of tax collection in the remaining months of FY25 needs to be significantly higher than the current rate to meet the revenue target for the fiscal year.
Meanwhile, the fiscal consolidation achieved in the past couple of years has supported monetary policy in bringing inflation down and restoring overall macroeconomic stability. As a result, the gross public debt to GDP ratio has significantly improved, declining from 75% at the end of June 2023 to 67.2% at end-June 2024. Going forward, the MPC expected fiscal consolidation to continue through reforms aimed primarily at broadening the tax base and curtailing PSE losses (particularly by addressing energy sector issues), creating additional space for social and development spending.
Taking into account these developments, as well as the potential risks to the inflation outlook and today's decision, the MPC assessed the real interest rate to still be adequately positive to bring inflation down to the medium-term target of 5%-7% and help ensure macroeconomic stability. This would be essential to achieving sustainable economic growth over the medium term.
Impact on market
According to an analysis by brokerage firm Topline Securities, the interest rate cut was "positive for high leverage, cyclical, and consumer discretionary companies. The leverage companies will benefit from the lower finance costs, cyclicals will benefit from the recovery of the economy, and consumer discretionary companies like autos will benefit from the expected rise in consumer financing."
Moreover, Topline hoped that the rate cut would benefit the country's export-oriented textile sector due to its high leverage, with a positive impact of 7%-10%, Steels with 5%-6%, and the Cement sector with 4%-6%.
Banks, however, are expected to see earnings decline of 7%- 10% due to the narrowing spread of the policy rate and discount rate, which has come down to 18.5%.