KARACHI/ISLAMABAD: The State Bank of Pakistan (SBP) Monday reduced the interest rate by 1 percent or 100 basis points (bps) from 20.5pc to 19.5pc, the second cut in a row, citing a slight cooling in the inflation rate — a move that is mostly in line with the general market consensus.
Meanwhile, Fitch Ratings has upgraded Pakistan’s credit rating to CCC+, citing reduced external funding risks following a new bailout from the International Monetary Fund (IMF). Addressing a press conference after the Monetary Policy Committee (MPC) meeting, SBP Governor Jameel Ahmad said, “We have noted that the inflation is on a declining trend.”
“The inflation rate has come down to 12.60pc from 38pc while the external account has continued to improve,” the SBP governor said adding, “The reduction in the interest rate reflects our confidence in the current economic trajectory.”
Last month, the SBP’s MPC trimmed its benchmark interest rate by 150 bps to 20.5pc, following a record-high 22pc that had been maintained for almost a year.
The finance czar further stated that “future projections expect the average inflation rate to stabilise between 23pc and 25pc, following last year’s 23.4pc”.
The central bank said the announcement of monetary easing showed positive indicators for the national economy citing a slight drop in inflation, a build-up in SBP’s foreign exchange (FX) reserves despite repayments of debt, and a staff-level agreement with the IMF for a 37-month extended fund facility (EFF) programme of about $7 billion.
It added that the committee assessed that the external account has continued to improve, as reflected by the build-up in the central bank’s FX reserves despite substantial repayments of debt and other obligations.
The developments – along with significantly positive real interest rates – led to the further reduction in the policy rate in a calibrated manner to support economic activity, while keeping inflationary pressures in check.
Since its last meeting, the committee noted the key developments that the current account deficit narrowed sharply in FY24 and SBP’s FX reserves improved significantly from $4.4 billion at the end of June 2023 to above $9 billion.
The sentiment surveys conducted in July showed a worsening in inflation expectations and confidence of both consumers and businesses, the statement read. It adds that international oil prices have remained volatile in recent weeks, whereas prices of metals and food items have eased. Lastly, with the ease in inflationary pressures and labour market conditions, central banks in advanced economies have also started to cut their policy rates.
Taking stock of the developments, the MPC assessed that, despite today’s decision, the monetary policy stance remains adequately tight to guide inflation towards the medium-term target of 5pc-7pc.
The assessment is also contingent on achieving the targeted fiscal consolidation, timely realisation of planned external inflows and addressing underlying weaknesses in the economy through structural reforms, it added.
Real sector
“Latest high-frequency indicators continue to reflect moderate economic activity. Auto and POL (excluding FO) sales and fertiliser offtake increased on a month-on-month basis in June. Large-scale manufacturing also recorded a sharp improvement in May 2024, mainly driven by the apparel sector.”
“The growth in agriculture sector, after showing a strong performance in FY24, is expected to slow down in this fiscal year. Latest satellite images and input conditions for Kharif crops also support this assessment.”
However, activity in the industry and services sectors is expected to recover, supported by relatively lower interest rates and higher budgeted development spending. Based on this, the MPC assessed FY25 real GDP growth in the range of 2.5pc to 3.5pc as compared to 2.4pc recorded last year.
External sector
After recording surpluses for three consecutive months, the current account posted a deficit in May and June, in line with the MPC’s expectation. The recorded deficits were largely due to higher dividend and profit payments and a seasonal increase in imports, which more than offset a significant increase in exports and workers’ remittances.
Cumulatively, the current account deficit in FY24 narrowed significantly to 0.2pc of GDP from 1.0pc in the preceding year. This, along with the revival of financial inflows, helped build the SBP’s FX reserves.
Looking ahead, the MPC expects a modest increase in imports, in line with the growth outlook. At the same time, the continued robust growth in workers’ remittances, along with an increase in exports, is expected to contain the current account deficit in the range of 0-1.0pc of GDP in FY25.
The committee assessed that the expected financial inflows, including planned official flows under the IMF program, would help finance this current account deficit and further strengthen the FX buffers.
Fiscal sector
The government’s revised estimates indicate improvement in fiscal balances during FY24, as the primary balance turned into a surplus and the overall deficit declined from last year. However, amidst a shortfall in budgeted external and non-bank financing, the government’s reliance on the domestic banking system increased significantly.
The committee expressed concern about increasing reliance on banks for deficit financing, which has been squeezing borrowing space for the private sector.
For FY25, the government has set the primary surplus target at 2.0pc of the GDP. The MPC emphasised achieving the envisaged fiscal consolidation and timely realisation of planned external inflows to support overall macroeconomic stability and build fiscal and external buffers for the country to respond to future economic shocks.
Money and credit
The committee noted that the trends and composition of monetary aggregates during FY24 remained consistent with the tight monetary policy stance. Broad money (M2) and reserve money grew by 16.0pc and 2.6pc, respectively, well below the growth in nominal GDP. Almost the entire growth in M2 was led by bank deposits, while currency in circulation remained almost at last year’s level.
As a result, the currency-to-deposit ratio improved, as it declined from 41.1pc at end-June 2023 to 33.6pc at end-June 2024.
At the same time, the improvement in external account increased the contribution of net foreign assets in monetary expansion. Meanwhile, the growth in net domestic assets of the banking system decelerated amidst subdued demand for private sector credit. The Committee viewed these developments as favourable for the inflation outlook, the statement read.
Inflation outlook
As expected, headline inflation rose to 12.6pc on a year-on-year basis in June 2024 from 11.8pc in May. This increase was primarily driven by higher electricity tariffs and Eid-related increase in prices, which were partly offset by the downward adjustments in domestic fuel prices.
Core inflation, meanwhile, has steadied around 14pc over the past two months. The MPC assessed that while the inflationary impact of the FY25 budget is largely in line with expectations, the available information indicates that the full impact of these measures may now take some time to fully reflect in domestic prices.
At the same time, the Committee noted risks to the inflation outlook from fiscal slippages and ad-hoc decisions related to energy price adjustments. On balance, after considering these trends – and accounting for the sufficiently tight monetary policy stance and ongoing fiscal consolidation – average inflation is expected to remain in the range of 11.5-13.5pc in FY25, down significantly from 23.4pc in FY24.
Also, Fitch Ratings raised Pakistan’s long-term foreign-currency issuer default rating (IDR) to CCC+ from CCC. Fitch typically does not assign outlooks to sovereigns with a rating of CCC+ or below.
While still below investment grade, the upgrade suggests a lower likelihood of default, analysts said reacting to the development. However, the agency warned that renewed deterioration in external liquidity conditions, delaying IMF programme reviews, or indications that the authorities were considering debt restructuring could lead to downgrades in future.
“The upgrade reflects greater certainty over the continued availability of external funding, in the context of Pakistan’s SLA (staff-level agreement) with the IMF on a new 37-month US$7 billion EFF (extended fund facility),” Fitch said in a handout released on Monday.
According to the rating agency, strong performance on the previous, more temporary IMF arrangement helped the country narrow fiscal deficits and rebuild foreign exchange (FX) reserves, and further improvements are likely.
“Nevertheless, Pakistan’s large funding needs leave it vulnerable if it fails to implement challenging reforms, which could undermine programme performance and funding,” it warned. Fitch said Pakistan and the IMF reached the SLA on 12 July. Highlighting the fiscal struggles that lie ahead for Pakistan, the rating agency notes that before likely IMF board approval by end-August, the government will have to obtain new funding assurances from bilateral partners, chiefly Saudi Arabia, the UAE and China, totalling about $4 billion-5 billion throughout the EFF.
“We believe this will be achievable, given the strong record of support and significant policy measures in the recent budget for the fiscal year ending June 2025 (FY25),” Fitch said.
It said Pakistan completed its nine-month Stand-by Arrangement with the IMF in April, while over the past year, it raised taxes, cut spending and raised electricity, gas and petrol prices. The agency observed that the government also all but eliminated the gap between the interbank and parallel market exchange rates through a crackdown on the black market and regulation of exchange houses.
Pakistan has been struggling with boom-and-bust cycles for decades, leading to 22 IMF bailouts since 1958. Currently the IMF is fifth-largest debtor, owing $6.28 billion as of July 11, according to the lender’s data.
The latest economic crisis has been the most prolonged and has seen the highest ever levels of inflation, pushing the country to the brink of a sovereign default last summer before an IMF bailout.
The conditions of the programme have become tougher. The latest bailout is aimed at cementing stability and inclusive growth in the crisis-plagued South Asian country, the IMF said. Fitch, in its detailed report, also shed light on several key challenges faced by Pakistan, including political and economic fronts. The Fitch report noted that the PMLN and allies received a weaker-than-expected mandate in the February elections. It points out that the current government’s position weakened further following a Supreme Court verdict favouring the Pakistan Tehreek-e-Insaf (PTI), impacting the position of the ruling party and its allies.
The report stated that despite being in jail since May 2023, the PTI founder remains popular among the populace, indicating continued political volatility in Pakistan.
Meanwhile, Prime Minister Shehbaz Sharif Monday hailed the upgrading of Pakistan’s long-term foreign currency issuer default rating (IDR) from CCC to CCC+ by the Credit Rating Agency Fitch.
Appreciating the efforts of Finance Minister Muhammad Aurangzeb and his team, the prime minister said the country and the nation had started receiving the fruits of the government’s policy of sacrificing politics for the sake of the state in the shape of improvement in the country’s economy.
He said upgrading Pakistan’s global rating to CCC+ was the international recognition of the government’s right economic policies. The PM emphasised that the government was working hard on the economic reforms agenda, the fruits of which would surely reach people soon.
The reports of Fitch and other international financial institutions are important for economic improvement of Pakistan, PM Shehbaz said adding, “We will move forward with more effort and passion on the path of economic improvement of the country.”
He hoped that the new IMF programme would further improve the economic activities in the country. The announcement of another one per cent reduction in interest rate by the SBP was another sign of economic improvement, he added. He said the cut in the interest rate would further reduce inflation and increase business activities.
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