Pakistan's central bank ends 2024 with yet another rate cut of 200bps

Pakistan's central bank slashed the key policy rate by another 200 basis points (bps) on Monday, bringing it down to 13%, a two-year low.

The State Bank of Pakistan began the monetary easing cycle in June after a gap of four years, during which the interest rate reached a record high of 22%. Since then, it has cut the rate by 900bps — the highest-ever reduction in a single year.

This is also the lowest rate since May 2022, when it was 13.75%.

Pakistan's inflation had started rising sharply in 2022 amid an economic crisis, reaching a peak of 38% in May 2023. However, it started easing this year, with inflation for November being recorded at a 6.5-year low of 4.9% in November.

The rate cut is in line with a survey of brokerage houses and banks conducted by Nukta last week.

Analysts and businessmen widely expect that this cut would be the last big trimming of the interest rate, with the central bank leaning towards a slower stance from January since the base-year effect would be over.

It is expected that inflation might once again reach double-digits in March and April, halting further consecutive declines in the interest rate.

With the inflation rate of December once again falling below 5%, there might still be room for another cut in the range of 100-200 bps, possibly sixth in a row.

On a fiscal year basis, the overall annual rate cut would be higher in any given year.The Monetary Policy Committee noted the following key developments since its last meeting that may have implications for the macroeconomic outlook.

First, the current account remained in surplus for the third consecutive month in October 2024, which, amidst weak financial inflows and substantial official debt repayments, helped increase the SBP’s FX reserves to around $12 billion.

Second, global commodity prices remained generally favourable, with positive spillovers on domestic inflation and the import bill.

Third, credit to the private sector recorded a noticeable increase, broadly reflecting the impact of ease in financial conditions and banks’ efforts to meet the advances-to-deposit ratio (ADR) thresholds.

Lastly, the shortfall in tax revenues from the target has widened.

Based on these developments, the Committee assessed that the impact of the cumulative reduction in the policy rate from June 2024 is beginning to unfold and will continue to materialize over the next few quarters.

In this context and taking into account today’s decision, the Committee noted that the real policy rate remains appropriately positive to stabilize inflation within the target range of 5 – 7 percent.

Real Sector

The incoming data indicates improved prospects for economic growth. In the agriculture sector, downside risks to the overall crop outlook have somewhat subsided.

This is based on better than expected cotton arrivals since the last MPC meeting and encouraging initial information, including satellite images, pertaining to sowing area of the wheat crop. Also, activity in the industrial sector is gaining further traction. Key large-scale manufacturing sectors – such as textile, food, automobiles, POL and tobacco – were already depicting strong growth till Q1-FY25.

Moreover, the latest high-frequency indictors – such as domestic sales of cement, auto, fertilizer and POL products – suggest that this momentum in industrial activity is continuing.

The knock-on impact of these improved prospects for the commodity-producing sectors and reduced inflationary pressures would support the services sector as well.

Going forward, improving business confidence and easing financial conditions are expected to support economic growth. Considering these developments, the MPC expects the real GDP growth in FY25 to remain in the upper half of the projected range of 2.5 – 3.5 percent.

The revised data for fiscal operations showed improvement in both the overall and primary balances during Q1-FY25. FBR revenues grew by 23 percent y/y during July-November FY25. This is, however, substantially lower than the required growth to achieve the annual tax collection target.

On the expenditure side, the declining yields will lead to a sizeable saving in interest payments on domestic debt compared to the budget estimates. These lower interest payments will help the government to contain the fiscal deficit; however, achieving the targeted primary surplus would be challenging.

In this regard, considerable efforts and additional measures would be required to meet the annual revenue target. This highlights the importance of fiscal reforms to broaden the tax base to achieve the targeted fiscal consolidation.

Inflation

Headline inflation eased further to 4.9 percent y/y in November from 7.2 percent in the previous month. This sharp decline was mainly driven by a favourable base effect from gas prices, along with the continued moderation in food inflation and benign global commodity prices.

The Committee noted that these factors are likely to continue in the near term and may bring headline inflation even lower in the coming months.

Accordingly, the Committee assessed FY25 inflation to average substantially below its earlier forecast range of 11.5 – 13.5 percent. Meanwhile, it was observed that core inflation declined marginally in November, while consumers’ inflation expectations inched up further.

At the same time, the inflation outlook is susceptible to multiple risks, including additional measures to meet the revenue shortfall, resurgence in food inflation and an increase in global commodity prices.

Notwithstanding these risks and the expected phase out of the favourable base effect, the Committee, on balance, viewed that the monetary policy stance remains appropriate to stabilize inflation in its target range.