Pakistan central bank slashes interest rate to 17.5%

Pakistan's central bank slashed the interest rate by 200 basis points (bps) on Thursday, bringing it down to 17.5% from 19.5%.

This was the State Bank of Pakistan's (SBP) third consecutive cut and follows an easing in inflation, which fell to the single-digit range in August for the first time in three years.

The decision was made in a Monetary Policy Committee meeting that reviewed key economic indicators and assessed the results of the last meeting. Following are the key developments since the July 29 meeting:

• Both headline and core inflation have fallen sharply over the past two months.
• Global oil prices have fallen sharply, though they remain volatile.
• SBP's foreign exchange reserves are around $9.5 billion as of September 6.
• Secondary market yields of government securities have declined noticeably.
• Inflation expectations and confidence of businesses have improved in the latest pulse surveys.
• The FBR tax collection during July-August was lower than the target.

The decision could kickstart the industrial cycle, which has been bogged down by higher utility prices and an interest rate that is the highest in the region.

The SBP's Monetary Policy Committee considers the real interest rate to be "adequately positive" to attain the medium-term target of 5-7% inflation target contingent on fiscal consolidation and timely foreign inflows.

In August, inflation was recorded at 9.6%, down from 11.1% in July.

The MPC observed that pace of disinflation had "somewhat exceeded" its earlier expectations.

Key takeaways from policy statement

• The State Bank expects average inflation to fall below the earlier forecast range of 11.5%–13.5% for FY25 subject to continuation of fiscal consolidation and healthy foreign inflows.
• The real GDP growth outlook remains in line with the MPC's earlier assessment of 2.5%–3.5% for FY25.
• Import volumes are expected to increase in line with the ongoing domestic economic recovery. However, the improvement in the country’s terms of trade, mainly driven by softening crude oil prices, is expected to contain the overall trade deficit in FY25.
• MPC observed that these factors, along with robust workers' remittances, are expected to keep the current account deficit within the projected range of 0–1% of GDP in FY25. Analysts expect CAD for FY25 to range between $3 to $4 billion.
• During July-August FY25, FBR tax collection grew by 20.5%. The MPC noted that the pace of tax collection in the remaining months of FY25 needs to be significantly higher than the current rate to meet the revenue target for the fiscal year.
• The broad money (M2) growth decelerated to 14.6% as of end-August, from 16.1% at end-June. The SBP attributed this deceleration to more than seasonal retirements in private sector credit and commodity operations financing.
• Gross domestic debt to GDP recorded significant improvement.
• Debt declined from 75% to 67.2% of GDP by end-June.
• Fiscal consolidation to continue through reforms primarily from broadening tax base and curtailing losses of state-owned companies.

The central bank had started easing monetary policy in June with a cut for the first time in four years. Since then, interest rates have been slashed by 450bps, the second-highest volume cut after the 2020 pandemic. During 2020, the central bank cut interest rates by 625bps to give much-needed impetus to local industries.

The real interest rate of 9.9% generates expectations of a further rate reduction. Although International Monetary Fund-led budgetary measures could partially mitigate the base effect impact on inflation, the economy is likely to continue to develop in accordance with the general trend in inflation and the RIR outlook.

The overall economic indicators are on a positive trajectory. In July, current account deficit narrowed by 48% month-on-month to $162 million.

Pakistan's current account balance decreased by 79% in FY24, generating a deficit of $665 million, the lowest in 13 years.