Pakistan’s central bank cut its key interest rate for the fifth time this year and for the third month in a row, saying this decision reflects a further improvement in the outlook for inflation while the slowdown of the country’s economy continues and downside risks to growth have risen.
The State Bank of Pakistan (SBP) cut its policy rate by another 100 basis points to 7.0 percent and has now cut it by 625 points this year following previous cuts in March, April and May.
Noting its mandate to support households and businesses through the Covid-19 pandemic and to minimize the damage to the economy, SBP’s monetary policy committee said after a surprise meeting that from a risk management point of view “a prompt response to downside risks to growth was called for given the improved inflation outlook.”
The central bank added that some 3.3 trillion rupees of loans were due to be repriced by early July, making this an opportune moment to take action as the benefits of interest rate reductions would be passed on to households and businesses in a timely manner.
Pakistan’s inflation rate eased to 8.22 percent in May from 8.5 percent in April and 14.6 percent in January due to the government’s cut in diesel and petrol prices and SBP said data shows this moderation was continuing in June despite a rise in some food prices, such as wheat.
While supply shocks could trigger some volatility in inflation, SBP said this was likely to be transitory given the weak demand and given the absence of any demand-side pressures, average inflation could fall below the previously expected range of 7-9 percent in fiscal 2020/21, which begins July 1.
In May SBP also forecast inflation for the current fiscal year to be close to the low end of its expected range of 11-12 percent.
“With the current reduction in the policy rate to 7 percent, the MPC felt that real rates on a forward-looking basis (defined as the policy rate less expected inflation) would be kept close to zero, which is appropriate under the current circumstances,” SBP said.
High-frequency data, such as cement dispatches, automobile sales, food and textile exports, and petroleum sales were continuing to contract in April though the rate was lower than in the previous two months and looking ahead SBP expects a gradual recovery in the fiscal 2021 although risks are still skewed to the downside and dependent on the evolution of the pandemic.
Pakistan’s rupee, which had stabilized in June last year after an agreement with the International Monetary Fund (IMF), fell sharply in March but then recovered in April. But since late May the rupee has again been falling and was trading at 167.4 to the U.S. dollar today, down 7.5 percent this year.
SPB said the flexible exchange rate had played “its valuable shock absorber role,” helping cushion the economy from any tightening of financial conditions from capital outflows and deteriorating global sentiment, adding the rupee’s depreciation had been lower than in many other emerging markets, reflecting the increased reserve buffers accumulated over the last year.
1. At its meeting on 25th June 2020, the Monetary Policy Committee (MPC) decided to reduce the policy rate by 100 basis points to 7 percent. This decision reflected the MPC’s view that the inflation outlook has improved further, while the domestic economic slowdown continues and downside risks to growth have increased. Against this backdrop of receding demand-side inflation risks, the priority of monetary policy has appropriately shifted toward supporting growth and employment during these challenging times.
2. Consistent with its mandate, the MPC re-asserted its commitment to supporting households and businesses through the Covid-19 crisis and minimizing damage to the economy. In this context, the MPC felt that from a risk management point of view, a prompt response to downside risks to growth was called for given the improved inflation outlook. In addition, the MPC noted that with approximately Rs. 3.3 trillion worth of loans due to be repriced by early July 2020, this was an opportune moment to take action from a monetary policy transmission perspective. In this way, the benefits of interest rate reductions would be passed on in a timely manner to households and businesses.
3. The MPC noted that the Covid-19 pandemic is spreading in many emerging markets, including Pakistan, and there are fears of a second wave in several other countries. The MPC observed that risks to the global outlook are heavily skewed to the downside and the path of recovery remains uncertain. The MPC also noted that in its update of the World Economic Outlook (WEO) released yesterday, the IMF downgraded its 2020 global growth forecast further to -4.9 percent, 1.9 percentage points lower than in April, and projected a more gradual recovery than previously anticipated.
4. Domestically, the moderation of underlying inflation has continued. Notwithstanding a seasonal uptick in food prices associated with the Eid holiday, headline inflation declined further to 8.2 percent in May on the back of the recent cut in diesel and petrol prices. In addition, month-on-month inflation rates continue to be low. Recent SPI data also suggests continued moderation in overall price pressures in June, despite price increases in some food items, notably wheat. The FY2020/21 budget is also expected to be neutral for inflation as the freeze on government salaries, absence of new taxes, and lower production cost from reduced import duties should offset the decline in subsidies in some sectors. While supply shocks could create some volatility in inflation, the MPC felt that these are likely to be transitory given weak domestic demand, such that monetary policy should generally look past them. Given the absence of demand-side pressures, average inflation could fall below the previously announced range of 7-9 percent for next fiscal year. With the current reduction of the policy rate to 7 percent, the MPC felt that real rates on a forward-looking basis (defined as the policy rate less expected inflation) would be kept close to zero, which is appropriate under the current circumstances.
5. On the real side, the decline in LSM deepened to 41.9 percent (y/y) in April, when lockdowns were still in place. In May, high-frequency indicators of activity such as cement dispatches, automobile sales, food and textile exports, and POL sales also continued to contract, although mostly at a lower rate than in the previous two months. Looking ahead, the economy is expected to recover gradually in FY21, supported by easing lockdowns, supportive macroeconomic policies and a pick-up in global growth. However, risks are skewed to the downside and the recovery will depend critically on the evolution of the pandemic both in Pakistan and abroad.