Policy rate slashed for sixth time

SBP reduces rate by 100 bps to 12% amid C/A surplus, increase in revenue

KARACHI:

The monetary policy committee (MPC) of the State Bank of Pakistan (SBP), in its meeting on Monday, announced the sixth successive reduction in policy rate, bringing it down by 100 basis points (bps) to 12%, effective January 28, 2025.

The decision comes amid key economic developments, including improved activity in the real sector, a cumulative surplus in current account, a significant increase in revenue and a rapidly declining inflation. "At its meeting today (Monday), the MPC decided to cut the policy rate by 100 bps to 12%, effective from January 28, 2025," SBP Governor Jameel Ahmad said at a press conference after the meeting.

The decision reflects optimism over declining inflation, which reached 4.1% in December, driven by moderate domestic demand and supportive supply-side factors.

MPC highlighted improving economic activity, a current account surplus of $1.2 billion in 1HFY25 and a notable 26% increase in the Federal Board of Revenue's tax collection during the first half of the current fiscal year. However, challenges persist, including a modest 0.9% GDP growth in 1QFY25, high core inflation and fiscal revenue shortfalls.

This policy stance aims to ensure price stability while maintaining the real policy rate within a positive range, with inflation expected to average between 5.5% and 7.5% for FY25. The SBP governor said headline inflation decreased fast from 38% in May 2023 to 4.1% in December and it may even further decrease for the next few months before resuming upward trajectory in June 2025.

The declining trend in inflation is mainly led by the downward adjustment in electricity tariffs, adequate supply of key food items leading to low levels of food inflation, stability in exchange rate and a favourable base effect, MPC said.

Underlying inflationary pressures, as indicated by the core inflation, also moderated amidst contained domestic demand, though these remain elevated. Moreover, inflation expectations also remained volatile.

Based on these trends, the MPC reiterated its earlier assessment that the near-term inflation would remain volatile and was expected to increase close to the upper bound of the target range towards the end of FY25. On balance, the MPC expects headline inflation for FY25 to average between 5.5% and 7.5%. Going forward, inflation outlook is subject to risks emanating from volatile global commodity prices, protectionist policies in major economies, timing and magnitude of administered energy tariff adjustments, volatile perishable food prices as well as any additional measures to meet the revenue target.

Driven by strong workers' remittances and export earnings, the current account posted a surplus of $0.6 billion in December, bringing the cumulative surplus to $1.2 billion during 1HFY25. Led by HVA textile, exports maintained a strong momentum. At the same time, import growth also showed broad-based acceleration on the back of higher volumes, pointing towards improvement in economic activity. While the import bill outpaced export earnings, remittance inflows more than offset the widening trade deficit.

Based on these trends, particularly the robust remittances, the current account outlook has improved considerably and it is now expected to remain between a surplus and deficit of 0.5% of GDP in FY25. Meanwhile, net financial inflows, though tepid during 1HFY25, are expected to improve as a sizable part of official debt repayments has already been made. Consequently, the improved current account outlook, along with expected realisation of planned financial inflows, is likely to increase the SBP's foreign currency reserves beyond $13 billion by June 2025.

The latest high-frequency indicators show sustained economic momentum, with increases in automobile, petroleum and fertiliser sales, import volumes, electricity generation and private sector credit disbursement. However, the real GDP growth slowed to 0.9% in 1QFY25 from 2.3% in 1QFY24, mainly due to a sharp decline in agricultural growth to 1.2%.

Key industrial sectors like textile, food and automobiles improved, while business confidence remains positive. MPC projects GDP growth to remain between 2.5% and 3.5%.

FBR's revenues grew 26% in 1HFY25, but tax collection fell short of targets, requiring rapid growth to meet annual goals. Lower interest payments are expected to keep fiscal deficit near target, though achieving primary balance remains challenging. Government borrowing shifted to non-bank sources, while private sector credit surged.