Cautious optimism

On Thursday, the State Bank’s Monetary Policy Committee (MPC) matched expectations, and demands, for a significant policy rate cut and decided to lower the key rate by 200 basis points (bps) to 17.5 per cent from the previous 19.5 per cent. This is the deepest rate cut in 53 months and the decision follows a sharper-than-expected decline in the headline and core inflation rates last month, with the former falling to a 34-month low of 9.6 percent. The policy rate decision is a welcome sign for an economy desperate for relief, but any sense of optimism must be tempered by the significant risks that lie ahead. The MPC has attributed the pace of disinflation to the delay in the implementation of planned increases in administered energy prices and favourable movement in global food and oil prices. While the lower policy rate could help boost economic activity, lower the debt-servicing burden and help make the fiscal debt more manageable, the path towards future rate cuts remains uncertain. The committee has highlighted the role of the tight monetary policy stance in driving a sustained decline in inflation over the past year and some risks to the near-term inflation outlook. The fact is that Pakistan’s battle with inflation is far from over. While headline inflation has declined, core inflation remains stubbornly high, and the public’s inflation expectations have actually risen. This signals lingering anxiety about future price hikes, particularly in energy costs, which remain a major uncertainty. The timing and scale of future adjustments to energy prices, along with potential global commodity price shifts, continue to cast a shadow over the inflation outlook. Add to this the looming threat of additional taxation measures to meet revenue shortfalls, and the picture becomes much murkier.

While the MPC has suggested that the average inflation for the current fiscal year might fall below the previously forecast range of 11.5 per cent to 13.5 per cent, this is contingent on achieving the targeted fiscal consolidation and realization of planned external inflows. In short, while there are growing signs of improved macroeconomic stability, any optimism about the economy has to be strongly tempered by caution. As such, the MPC’s outlook for real growth remains within the modest range of 2.5 per cent to 3.5 per cent for FY25. A country facing the demographic and resource pressures that Pakistan does need to grow at a much faster pace to meet the needs and expectations of its people, but for now economic stability appears to be a bigger priority than growth.

The fiscal challenges facing Pakistan are perhaps the most troubling part of the economic equation. The MPC has made it clear that the government’s ability to manage inflation expectations – and by extension, economic stability – will depend heavily on its success in achieving fiscal consolidation. The reform agenda aimed at broadening the tax base and curtailing losses in the public sector has been discussed for years but remains largely unfulfilled. The first quarter of the current fiscal year has already seen a worrying shortfall in revenue collection, highlighting the persistent gaps in Pakistan’s financial management. Public-sector enterprises remain a bleeding wound on the nation’s finances. Successive governments have failed to stem the losses from these institutions, despite numerous pledges and reform attempts over the past quarter-century. Without addressing this issue, meaningful fiscal consolidation will remain elusive, and Pakistan will continue to struggle under the weight of unsustainable debt. The central bank’s caution on this is thus understandable – there are too many structural problems for anyone to declare a victory just yet. Ultimately, the MPC’s rate cut is no magic bullet and to stay the course, Pakistan will need the current and any future governments to make the sorts of tough, politically costly changes that they have previously shied away from.