The State Bank of Pakistan (SBP) has lowered its key policy rate by 200 basis points (bps) to 17.5%, exceeding expectations of a 150bps cut. This move marks the third consecutive rate reduction since June 2024, totaling 450bps, as inflation continues to decline, giving policymakers room to stimulate economic growth.
Inflation Trends and Real Interest Rate
Pakistan’s annual inflation rate eased to 9.6% in August from 11.1% in July, expanding the real interest rate to 9.9%. The central bank noted that both headline and core inflation have fallen more rapidly than expected, driven by delayed energy price hikes and favorable global commodity prices. The two-month average inflation for FY25 stands at 10.4%, a significant drop from 27.8% in the same period last year.
Key Developments Impacting Monetary Policy
The SBP’s Monetary Policy Committee (MPC) identified several factors influencing its decision:
- Global Oil Prices: A sharp decline in oil prices, though they remain volatile.
- FX Reserves: As of September 6, SBP’s foreign exchange reserves stood at $9.5 billion, despite weak inflows and ongoing debt repayments.
- Government Securities: Yields on government securities have fallen, reflecting easing market conditions.
- Business and Consumer Sentiment: Business confidence has improved, while consumer sentiment has slightly worsened.
- Fiscal Challenges: FBR tax collection fell short of targets during July-August 2024.
Outlook on Economic Growth and Inflation
The SBP maintained its GDP growth projection at 2.5–3.5% for FY25. While industrial and services sectors are expected to benefit from monetary easing, the agriculture sector faces challenges due to lower cotton production. Despite inflation’s sharp decline, core inflation remains elevated, and there is uncertainty around energy price adjustments and global commodity prices.
The central bank expects inflation to fall below its previous forecast of 11.5–13.5% for FY25, contingent on fiscal consolidation and timely external inflows.
External Sector and Trade Balance
Pakistan’s current account deficit narrowed to $0.2 billion in July 2024, supported by robust remittances and improved export earnings. With lower oil prices and stable export earnings, the SBP expects the trade deficit to remain contained. The current account deficit for FY25 is projected to stay within 0–1% of GDP, which, combined with IMF program inflows, will help strengthen FX reserves.
Fiscal and Monetary Policy Coordination
The SBP highlighted the need for continued fiscal consolidation to support monetary policy, emphasizing reforms to broaden the tax base and reduce public sector enterprise losses, particularly in the energy sector. The gross public debt-to-GDP ratio improved significantly, falling from 75% in June 2023 to 67.2% in June 2024.
The committee also noted a deceleration in broad money (M2) growth and emphasized the importance of planned official FX inflows to reduce reliance on domestic banks and improve lending to the private sector.
Conclusion
The SBP’s aggressive monetary easing, in response to a rapid decline in inflation, aims to support economic recovery while maintaining a cautious stance given uncertainties around global and domestic risks. The MPC remains optimistic that inflation will continue its downward trajectory, enabling sustainable economic growth in the medium term.
