SBP says inflation to stay low, but warns of some risks

KARACHI: Pakistan’s inflation is expected to stay low in the current fiscal year, mainly because of the lagged impacts of a tight monetary policy and ongoing fiscal consolidation, but there are potential risks from unexpected energy subsidies and fluctuating global commodity prices, the central bank said on Friday.

Macroeconomic conditions in the country improved in FY24, according to the State Bank of Pakistan’s Governor’s Annual Report for the fiscal year 2024. After two difficult years, inflation turned the corner thanks to ongoing tight monetary policy, fiscal austerity and generally favourable global economic conditions.

“Inflation is projected to remain significantly contained in FY25, particularly due to the lagged impact of tight monetary policy stance and continued fiscal consolidation,” the report said.Headline inflation has already been on a downward trajectory since June 2023 falling to 6.9 per cent in September 2024; global commodity prices continue to be low, whereas core inflation is also softening, it noted.

“These are indeed encouraging signs. However, upside risks could still emanate from global and domestic economic and political uncertainties, such as from slippages from envisaged fiscal consolidation, unplanned energy subsidies, or volatile global commodity prices in the wake of growing geo-political tensions,” the report said.

The fiscal consolidation is encouraging. With budgeted increase in direct and indirect taxes amid plans to widen tax net, the fiscal deficit in FY25 is projected to be lower than FY24, despite the government’s plans for higher development spending aimed at boosting economic growth, according to the report.

Although the pace of agriculture growth may soften in FY25, the slow but consistent recovery in LSM since December 2023, and the bottoming out of high-frequency demand indicators reflects steady improvements in real economic activities. The SBP believes this momentum, supported by lower borrowing costs and fall in global commodity prices, is expected to continue in the remaining period of FY25.

While moderate economic growth is expected to increase import volumes, its impact on trade balance may be muted by benign trends in global commodity prices, as per the report.At the same time, both the exports and workers’ remittances are projected to grow in continuation of the trends in FY24, leading to a sustainable current account deficit.

“This, coupled with the approval of the IMF’s $7 billion Extended Fund Facility programme, which typically paves way for other external inflows from multilateral and bilateral sources, is expected to further strengthen foreign exchange buffers,” it said.

Reflecting its confidence over receding inflationary pressures, the SBP’s MPC further reduced the policy rate by 350 bps in July and September 2024, taking the cumulative reduction to 450 bps since June 2024.

Despite this reduction, the real policy rate remains significantly positive, which the MPC considers appropriate to guide inflation towards the medium term target of 5-7per cent. The SBP will remain on guard to counter any threat to price and financial stability, which are critical for sustaining higher growth over the medium to long term.

The report noted that almost consistent decline in both headline and core inflation during the second half of the fiscal year, provided room to the monetary policy committee to reduce the policy rate by 150 basis points to 20.5 per cent in June 2024. The reduction was the first in 33-months, marking the gradual softening of the tight monetary policy stance.

Regarding the SBP’s objective of maintaining stability of the financial system, the report emphasizes the overall financial sector showed resilience amid falling but elevated inflationary pressures, and continued the provision of credit and financial services.

The report highlights that total banking-sector deposits saw a notable growth on account of elevated interest rates and SBP’s efforts towards financial inclusion and digitalisation of payments. At the same time, the growth in the banking sector’s loan delinquencies remained contained despite the tight monetary policy stance, whereas the banking sector’s capital adequacy ratio, assets quality and liquidity indicators also improved, enabling the financial sector to maintain overall financial soundness, the report said.