Karachi, November 4, 2024 – In a bold move, the State Bank of Pakistan (SBP) announced a significant reduction in the country’s benchmark interest rate by 250 basis points (bps), bringing it down to 15%. The central bank’s decision, effective from November 5, 2024, reflects growing confidence in the ongoing disinflation trend, with inflation moderating closer to the SBP’s medium-term target range.
In a statement following the Monetary Policy Committee (MPC) meeting, the SBP cited faster-than-anticipated declines in inflation as a key driver behind the rate cut. The recent disinflation has been bolstered by a confluence of favorable domestic and international factors, including a sharp drop in food prices, stable global oil markets, and the absence of projected increases in gas tariffs and Petroleum Development Levy (PDL) rates. This accelerated disinflationary trend is a promising signal for Pakistan’s economy, which has been grappling with high inflation for much of the past two years.
Key Factors Influencing the Policy Shift
Since the last MPC meeting, several macroeconomic developments have provided grounds for cautious optimism. Firstly, the International Monetary Fund (IMF) recently approved a new Extended Fund Facility (EFF) for Pakistan, signaling confidence in the country’s economic reforms and boosting the likelihood of anticipated foreign inflows. This IMF agreement has allayed investor concerns, improving overall market sentiment.
Surveys conducted in October 2024 revealed a notable rise in both consumer and business confidence, coupled with reduced inflation expectations. This uplift in sentiment has translated into improved yields in Pakistan’s government securities and a notable decline in the Karachi Interbank Offered Rate (KIBOR). The reduction in yields and borrowing rates signals an improving credit environment, which is expected to stimulate economic activity and investment.
However, the central bank remains wary of emerging risks. The fiscal deficit widened as tax collections in the first four months of FY25 fell short of targets, while global commodity prices continue to exhibit volatility, particularly metals and agricultural products. Escalating geopolitical tensions have injected additional uncertainty into the oil market, which could still disrupt the disinflationary trend if prolonged.
Real Sector Resilience and Economic Recovery
Pakistan’s real sector is showing signs of resilience, with economic activity gradually picking up. The agricultural sector’s major Kharif crops have delivered stronger-than-expected output, notably in rice and sugarcane, which have offset shortfalls in maize and cotton production. This bumper crop season is anticipated to boost rural income and, by extension, domestic demand in the months to come.
Moreover, Pakistan’s industrial sector is regaining momentum. Key industries such as textiles, food processing, and automotive have shown impressive growth during July and August 2024, reflecting both rising domestic demand and improved export competitiveness. The SBP has noted a corresponding increase in imports of raw materials and machinery, indicating renewed business confidence and preparation for sustained growth. These positive trends in the commodity and industrial sectors are expected to trickle down to the services sector, strengthening overall economic performance.
The MPC now expects real GDP growth in FY25 to exceed earlier projections, reaching an estimated range of 2.5% to 3.5%. While modest, this growth trajectory indicates a return to economic stability following a prolonged period of stagnation.
External Sector and Foreign Reserves
On the external front, Pakistan’s current account balance has shown significant improvement, posting a surplus for the second consecutive month in September 2024. This positive trend has narrowed the cumulative deficit to $98 million in the first quarter of FY25, driven by strong remittance inflows and higher export earnings.
The influx of funds from the first tranche of the IMF program has further bolstered the SBP’s foreign exchange reserves, now standing at $11.2 billion as of late October. This accumulation of reserves provides a buffer against external shocks and strengthens Pakistan’s capacity to meet its import requirements. Going forward, the MPC projects the current account deficit to remain manageable at 0-1% of GDP, with expectations of official inflows potentially raising reserves to $13 billion by June 2025.
Fiscal Sector Challenges and Reforms
The fiscal landscape presents a mixed picture. The government recorded fiscal and primary surpluses in the first quarter of FY25, driven largely by unprecedented profits from the SBP, which substantially boosted non-tax revenues. However, a shortfall in tax collections by the Federal Board of Revenue (FBR) during July-October raises concerns about achieving the FY25 tax revenue target.
Despite lower interest payments creating fiscal space, meeting the primary balance target remains challenging. The SBP emphasized the need for continued fiscal consolidation, highlighting reforms aimed at broadening the tax base and curtailing losses in public sector enterprises. Such fiscal discipline will be crucial to sustain macroeconomic stability and support future growth initiatives.
Money and Credit Markets: Boost for Private Sector
Pakistan’s money and credit markets have seen favorable developments. Broad money growth has increased modestly to 15.2% as of October, fueled by a substantial reduction in government borrowing from the banking system. This shift has allowed banks to redirect resources toward the private sector, stimulating investment and industrial expansion.
The SBP’s recent decision to limit liquidity injections, marked by a decline in outstanding open market operations (OMOs), indicates a strategic shift toward easing financial conditions. With banks likely to extend more credit to meet regulatory targets, private sector borrowing is expected to accelerate, particularly as demand for credit rises alongside economic recovery.
Inflation Trends and Outlook
Since the last MPC meeting, Pakistan has witnessed a pronounced decline in inflation, with year-on-year (y/y) rates dropping to 6.9% in September and 7.2% in October, down from 9.6% in August. This sharp decrease is attributed to subdued demand, improved domestic food supplies, and favorable global oil prices. The SBP now anticipates that inflation will continue to decline in the coming months, with FY25’s average inflation rate projected to fall below the previous forecast of 11.5-13.5%.
However, the MPC cautioned that risks remain. Escalating conflict in the Middle East, potential re-emergence of food price pressures, unexpected hikes in administered prices, or ad hoc tax measures could disrupt this favorable inflation outlook.
Balancing Growth and Stability
The SBP’s decisive 250-bps rate cut reflects a calculated shift toward fostering economic recovery while maintaining price stability. By aligning monetary policy with disinflationary trends and supporting economic activity, the SBP aims to achieve sustainable growth and macroeconomic stability. However, the road ahead requires vigilant monitoring of global and domestic developments, as Pakistan navigates its way out of economic headwinds toward a more stable and prosperous future.
