Pakistan anticipated to cut interest rates by another 100 basis points

The State Bank of Pakistan (SBP) is set to announce its monetary policy statement on January 27, with market analysts unanimously predicting a 100 basis points cut, bringing the rate down to 12%.

A survey conducted by Nukta of over a dozen brokerage houses revealed that all participants anticipate the 100bps cut.

Inflation in Pakistan is on a significant downward trend, with headline inflation projected to ease to 3.06% in January, marking the lowest level in nine years. Inflation is expected to remain below 5% through April 2025, driven by a favorable base effect.

However, a reversal is likely in May and June, with projections rising to 8.81% and 8.97%, respectively, as the base effect dissipates after the first quarter of 2025.

The sharp decline in inflation is attributed to several key factors, including a high base effect, stability of the Pakistani Rupee (PKR) against the U.S. Dollar (USD), and subdued prices in the food and energy sectors.

The real interest rate is projected to reach 9.98% in January, significantly higher than its historical average of 2.5%.

Additionally, the historical spread between the policy rate and core inflation has averaged around 1.7% over the past nine years, suggesting that the SBP has substantial room for further rate adjustments.

Pakistan's current account balance posted a surplus of $582 million in December 2024, bringing the first half of the fiscal year 2025 current account balance to $1.21 billion, primarily driven by higher remittances and a controlled trade deficit.

Despite a positive current account and a breakeven capital account, the balance of payments turned negative for the month due to loan repayments. However, the balance of payments remains positive for the first half of the fiscal year 2025.

Pakistan’s trade deficit climbed by 37% year-on-year to $2.5 billion in December 2024, the highest monthly deficit since April 2024, driven by a sharp rise in imports, which reached $5.4 billion.

Despite a recent 200bps cut in the policy rate last month, taking the cumulative cut in the last six months to 900bps, the ongoing sharp disinflation maintains a high real interest rate (RIR) level.

On normalized CPI levels of approximately 10%, expected in the long run, the RIR at the current policy rate stands at 3 percentage points.

Interestingly, a majority of investors believe that there may be more policy rate cuts going forward, given that inflation figures have come in lower than previously expected by the broader market.