KARACHI: Former deputy governor of Pakistan’s central bank Dr Murtaza Syed expects more interest rate cuts due to a decrease in inflation.
However, he emphasized that the extent of the cuts depends on continuation of a responsible fiscal policy and maintenance of control over the external situation, which is supported by the International Monetary Fund’s loan programme and sufficient external financing.
“Inflation has begun to decline amid tight policies and slow growth, allowing the policy rate to be cut last month for the first time in four years,” said Syed on Thursday at the Pakistan CFA Society’s seminar on monetary policy and exchange rate outlook for FY24-25.
“In the base case, inflation should continue to fall and provide scope for further interest rate cuts in FY25 to mid-double digits,” Syed added.
Syed, who is currently the head of the ecosystem at the Asian Infrastructure Investment Bank, made comments when the State Bank of Pakistan reduced its key interest rate by 150 basis points to 20.5 percent in June due to a significant decline in inflation. In June, Pakistan’s inflation accelerated for the first time in six months as energy costs increased. Consumer prices rose by 12.57 percent in June compared to the previous year. This was higher than the 11.8 percent year-on-year rise in May but well below the average reading of 23.4 percent for the financial year ending on June 30th.
“With the economy stabilizing, Pakistan negotiating another IMF programme that will demand fiscal discipline and provide support to the external accounts, and the real interest rate expected to become increasingly positive as inflation falls further, there should be scope for further cuts in policy rates (towards mid-double digits given IMF forecasts of 12.7 percent inflation in FY25 and need to keep real rates around 2-3 percent in steady state),” Syed said.
However, there is a need to proceed with caution, since inflation expectations are not yet anchored around the 5-7 percent medium-term target and the experience of 2022-23 cautions against declaring victory on fiscal discipline and external support too quickly, he added.
He said there was limited room for maneuver on the external front, as too aggressive a rate cut cycle could lead to an uncomfortable rise in imports and rupee volatility that generates another bout of inflation given the high exchange rate pass-through. “Scope to cut is contingent on fiscal policy remaining prudent, the effect of increases in taxes and administered prices in the budget on the path of inflation, and the external situation remaining under control under the aegis of an IMF programme and adequate external financing. Externally, global commodity prices need to be monitored.
“Finally, the growth rate has to be carefully watched, since rapid growth under the current economic model can quickly lead to balance of payments pressures in the form of a ballooning current account deficit and dwindling FX reserves,” he said.
According to Syed, the rupee should remain broadly stable but some depreciation is likely in FY25, pushing it toward the 300 range against the US dollar. However, there are plausible alternative scenarios with less scope for rate cuts and more significant exchange rate volatility.
Riaz Riazuddin, another former deputy governor of the SBP, said the ratio of government credit to GDP needs to be brought down so that private sector credit can go up. “This will only be possible if government revenues go up to meet at least its primary expenditure (total expenditure other than interest) and there is a surplus on primary account,” Riazuddin said.
He was of the view that the future economic betterment will also depend on support from friendly countries, besides, the IMF.