In a statement issued on Monday evening, the State Bank said its Monetary Policy Committee (MPC) had met earlier in the day and decided that economic conditions currently were at a level that did not require any change in the interest rates.
The committee noted that economic uncertainty, which had plagued the country for the past year, had decreased. It added that since their last meeting, the near-term external sector challenges of Pakistan have been largely addressed, while investor confidence has shown improvement.
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Cautioning that there were some upside risks to the inflation outlook, the committee reviewed how periodical belt-tightening of the policy was finally demonstrating itself in the economic figures. Further, budgeted fiscal consolidation and the tepid growth outlook for the incoming fiscal year 2023-24.
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However, it noted that things had not improved to a sufficient level to consider lowering the interest rates at this time.
The central bank said that a positive real interest rate on a forward-looking basis to keep inflation and its expectation on a downward path would help achieve medium-term inflation targets of five – seven percent by end-FY25.
Inflation going down
The committee noted that year-on-year (y/y) inflation is likely to remain on a downward path for the next 12 months. It said that this outlook implies a significant level of positive real interest rate.
It said that the national consumer price index (CPI) inflation had moderated considerably from its peak of 38 percent y/y in May 2023 to 29.4 percent in June.
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It expected y/y inflation to remain generally on a downward trajectory due to subdued domestic demand amid a tight monetary policy stance, favourable outlook for global commodity prices, and positive base effect.
This assessment takes into account the impact of recent measures (increase in electricity tariffs, changes in duties and taxes on consumer items and raw materials) and their second-round effects.
Based on this assessment, the MPC projects that average inflation will remain in the range of 20 – 22 percent for FY24, down from 29.2 percent in FY23.
The MPC's assessment shows inflation to fall gradually during the first half of FY24 before falling below 20 percent in the second half.
This outlook, nevertheless, is subject to risks arising from domestic and external shocks such as adverse climate events and global commodity price volatility.
Foreign exchange reserves get a boost
The committee noted since its last meeting on June 26, several important developments have impacted the country's short-term macroeconomic outlook.
The most important was that Pakistan had secured a nine-month Stand-By Arrangement (SBA) with the International Monetary Fund (IMF) worth around $3 billion.
This injection and the endorsement of an IMF programme have helped address immediate external sector stability concerns by supporting the country's flagging foreign exchange reserves.
With the disbursement of the first tranche under the SBA and another $3 billion secured in bilateral support, foreign exchange reserves with the central bank increased from $4.5 billion at the end of June 2023 to $8.2 billion as of July 21, 2023.
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Further, tax and other revenue measures introduced in the federal budget for the fiscal year 2023-24, including an increase in electricity tariffs, would address cash inflow issues on the domestic front. But the SBP warned it would contribute towards inflation in the coming months.
Another factor was commodity prices falling from their recent peak in the global markets.
On the external front, the IMF, in its latest economic outlook, has pointed to slightly more growth than previously projected.
With the current account balance recording a surplus for the fourth consecutive month in June, the cumulative current account deficit in FY23 substantially narrowed to 0.7 percent of GDP from 4.7 percent in FY22.
The MPC noted that this improvement primarily stems from policy-induced compression in imports, which more than offset the decline in exports and workers' remittances during the year.
Over the next 12 months, the current account deficit is expected to remain contained in the range of 0.5 to 1.5 percent of GDP in FY24.
On the financing side, the prospects of multilateral and bilateral inflows have considerably improved after the IMF SBA.
This is important in the context of building external buffers and meeting the near-term external financing needs.
Further, a market-determined exchange rate
will continue to serve as the first line of defence against external shocks and support reserve build-up.
Growth trajectory
While the latest high-frequency indicators up to June 2023 continue to show weak economic activity, they were broadly in line with the provisional estimates of 0.3 percent real GDP growth in FY23, a sharp decline from around 6 percent growth in the previous two years.
However, looking ahead, the MPC expected economic activity to recover moderately in FY24, supported by a rebound in rice and cotton output.
The committee further noted that improved business confidence and the withdrawal of curbs on imports had improved the outlook for manufacturing, construction and allied services.
But the high-interest rate will and expected fiscal consolidation will keep the economy from overheating and keep real GDP growth
within 2.0 to 3.0 percent for FY24.