SBP Keeps Policy Rate Unchanged Amid Lowering Inflation

Reduction in inflation broadly reflects the combined impact of SBP's monetary policy, fiscal consolidation, better food supplies, moderating global commodity prices and favourable base effect

SBP Keeps Policy Rate Unchanged Amid Lowering Inflation

The central bank on Monday decided to keep the policy rate unchanged at 22%, noting that while inflation has come down as expected, its outlook remains susceptible to risks amidst elevated inflation expectations.

In a detailed decision on keeping the interest rates constant, the State Bank of Pakistan's (SBP) Monetary Policy Committee (MPC) noted that inflation had witnessed a noticeable decline with a sharp deceleration in February. Despite that, the overall level of inflation remains high.

"This warrants a cautious approach and requires continuity of the current monetary stance to bring inflation down to the target range of 5% – 7% by September 2025."

The central bank warned that these expectations were contingent upon continued targeted fiscal consolidation and timely arrivals of external inflows.

The MPC also noted a few key developments in the economy since its last review. This includes the economy continuing to show a moderate pick-up in economic activity, led by a rebound in agricultural output, as reflected in the latest economic data.

Second, the external current account balance has turned out to be better than anticipated - thanks to foreign debt rollovers - which has helped maintain the foreign exchange buffers despite weak financial inflows. 

While business inflation expectations have shown a steady increase since December, those for consumers also increased in March. 

Lastly, on the global front, while the broader trend in commodity prices remained benign, oil prices have increased, partly reflecting the continued tense situation in the Red Sea. 

Due to the uncertainty regarding the inflation outlook, key central banks in advanced and emerging economies have maintained a cautious monetary policy stance.

The committee noted that, as per its expectations, there has been a moderate recovery in economic activity during fiscal year 2024, with real GDP growth remaining in the range of 2%—3%.

The agriculture sector remains the key driver of economic activity after a strong performance of Kharif crops (especially cotton and rice); prospects for wheat crops also look promising due to increased cultivated area, better input conditions, and higher output prices. 

A greater-than-average wheat crop, as captured by satellite images, also supports this assessment. 

The industrial sector and large-scale manufacturing, despite a slight decline of 0.5% between July and January, are expected to recover in the coming months due to improved capacity utilisation and employment conditions and a favourable base effect.

Furthermore, the knock-on impact of commodity-producing sectors and other leading indicators point towards gradual recovery in the services sector. 

External sector 

The SBP noted that the country's current account deficit stood at $269 million in January 2024, while its cumulative deficit between July and January FY24 was $1.1 billion. This, however, is down by around 71% year-on-year. 

The MPC noted that this improvement was largely due to increased exports and a simultaneous decline in imports.

The key aspect of exports was a larger component of food exports. The food import payments have been subdued due to improved domestic agriculture output, moderate domestic demand and lower global commodity prices. 

Moreover, workers' remittances have increased consistently since October 2023. This increase has been supported by incentives and regulatory reforms to channel inflows via formal channels. 

The SBP noted that the country's financial inflows showed a modest decline in January amidst continuing public debt repayments without significant official and private sector inflows. 

Despite these challenges, the MPC assessed that Pakistan's current account deficit is likely to remain closer to the lower end of the 0.5% to 1.5% range of GDP, which was forecast for FY24. This will also help maintain the position of foreign exchange reserves, which rose to $13 billion.

Fiscal sector

SBP said the latest data suggests continuing fiscal consolidation. During the first half of FY24, the primary surplus improved to 1.7% of GDP, up from 1.1% in the same period last year. 

The overall fiscal deficit, however, deteriorated to 2.3% of GDP from 2% in the same period last year. 

The central bank suggested that the primary surplus to GDP ratio improves due to better revenue collection, primarily from non-tax sources, and relatively contained non-interest expenditures. 

A sizeable increase in interest payments amidst high debt levels and increasing reliance on costly domestic financing has led to an expansion in the overall deficit.

The MPC emphasised that continuing fiscal consolidation is essential for ensuring overall macroeconomic and price stability.

Money and credit

Since the last MPC meeting, as expected, the broad money (M2) growth (y/y) has moderated to 16.1% in February 2024 from 17.8% in December. 

This moderation came from lower growth in the banking system's net domestic assets, owing mainly to a broad-based contraction in private sector credit and commodity financing operations due to the higher cost of borrowing.

The MPC also noted that the growth in reserve money continued to decelerate sharply to 8.2% in February. 

Moreover, the currency-to-deposit ratio continued to decline due to the strong growth in bank deposits and a declining trend in currency in circulation due to the higher rates offered.
These trends in monetary aggregates bode well for the inflation outlook.

Inflation outlook

The MPC noted that headline inflation registered a broad-based and considerable year-on-year decline from 28.3% in January to 23.1% in February. 

While food inflation continued to trend down, core inflation, which had been sticky, also decelerated from 20.5% in January to 18.1% in February.

The reduction in inflation broadly reflects the combined impact of SBP's monetary policy, fiscal consolidation, better food supplies, moderating global commodity prices and favourable base effect. 

The MPC noted that this period also saw a deceleration in energy inflation year-on-year, which was a contributing factor in February. Further adjustments in administered energy prices will contribute to inflation directly and indirectly. 

"This has implications for the needed sustained decline in inflation expectations of both consumers and businesses," the MPC statement read, adding, "Going forward, any further adjustments in administered prices or fiscal measures that may push prices up pose a risk to the near- and medium-term inflation outlook."

In view of these risks, the committee said that it would be prudent to maintain the current monetary policy stance at this stage.