Both headline and core inflation fell sharply over the past two months.

The pace of this disinflation has somewhat exceeded the Committee’s earlier expectations, mainly due to the delay in the implementation of planned increases in administered energy prices and favourable movement in global oil and food prices. At the same time, the Committee acknowledged the inherent uncertainty related to these developments, which warranted a cautious monetary policy stance.

In this regard, the Committee underscored the importance of the tight monetary policy stance in driving the sustained decline in inflation over the past year.

The MPC noted that global oil prices have fallen sharply, though they remain volatile while SBP’s FX reserves are around $9.5 billion as of September 6, despite weak official FX inflows and continued debt repayments.

The state bank in a statement issued said market yields of government securities have declined noticeably since the last MPC meeting. Fourth, inflation expectations and confidence of businesses have improved in the latest pulse surveys, while those of consumers have worsened slightly.

The FBR tax collection during July-August 2024 was lower than the target.

Taking into account these developments as well as the potential risks to the inflation outlook and today’s decision, the MPC assessed the real interest rate to still be adequately positive to bring inflation down to the medium-term target of 5 – 7 percent and help ensure macroeconomic stability.

Real Sector

Recent high-frequency sales indicators reflect a moderate pick up in the economic activity. Domestic cement and POL sales (excluding furnace oil) increased by 8.5 percent and 6.8 percent on m/m basis in August, respectively.

Latest business sentiment surveys also support this assessment of a moderate pickup, as manufacturing firms reported increased capacity utilization during the past couple of waves. At the same time, the MPC noted that the outlook for the agriculture sector has weakened.

This is attributed to an expected shortfall in cotton production from the government’s target, given the decline in area under cultivation and a substantial drop in cotton arrivals by end-August 2024.

The Committee observed that the continued ease in inflationary pressures and the unfolding impact of recent policy rate cuts will support the growth prospects in the industry and services sectors. On balance, therefore, the real GDP growth outlook remained in line with the MPC’s earlier assessment of 2.5 – 3.5 percent for FY25.

External Sector

In July 2024, elevated workers’ remittance inflows and a substantial improvement in export earnings offset an increase in imports and helped contain the current account deficit to $0.2 billion. This robust trend in workers’ remittances continued in August as well.

The global macroeconomic environment also turned favorable as manifested by the substantial softening of crude oil prices and relative easing of global financial conditions. Going forward, 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. Also, export earnings are expected to remain stable as the growth in high value added textiles is expected to compensate for the likely reduction in rice exports.

The 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 percent of GDP in FY25. This contained current account deficit, along with the realization of inflows planned under the IMF program, will help further strengthen SBP’s FX reserves.

Fiscal sector

During July-August FY25, FBR tax collection grew by 20.5 percent. 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.

Meanwhile, the fiscal consolidation achieved in the past couple of years has supported monetary policy in bringing inflation down and restoring overall macroeconomic stability.

As a result, the gross public debt to GDP ratio has recorded a significant improvement, declining from 75 percent at end-June 2023 to 67.2 percent at end-June 2024. Going forward, the MPC expected that the fiscal consolidation would continue through reforms aimed primarily at broadening of tax base and curtailing PSE losses (particularly by addressing energy sector issues), which would create additional space for social and development spending.

Money and credit

The broad money (M2) growth decelerated to 14.6 percent as of end-August 2024, from 16.1 percent at end-June, primarily due to more than seasonal retirements in private sector credit (PSC) and commodity operations financing.

The growth in reserve money, after remaining subdued during FY24, somewhat reversed, but is still lower than its historical trend. From the liability side, deposits remained the mainstay of M2 growth. The MPC emphasized that the planned official FX inflows will be critical for the government to reduce its reliance on the domestic banking sector, improve the NFA, and create space for lending to the private sector.

The MPC also viewed that the currently subdued growth in PSC may pick up with the ease in financial conditions.

Inflation outlook

Maintaining its downward trajectory, headline inflation eased to single digit to 9.6 percent y/y in August 2024 from 12.6 percent in June 2024 at the time of last MPC meeting, while core inflation declined to 11.9 percent from 14.1 percent.

The Committee assessed that this decline reflected the impact of contained demand, reinforced by improved supplies of major food items, favourable global commodity prices and delay in upward adjustments in administered energy prices.

At the same time, the MPC assessed the near-term inflation outlook to be susceptible to some risks. Core inflation is still high and consumers’ inflation expectations increased further in the latest survey.

Also, there is uncertainty stemming from the timing and magnitude of adjustments in administered energy prices, future course of global commodity prices, and any additional taxation measures to meet the shortfall in revenue collection.

On balance, the Committee viewed a possibility of FY25 average inflation falling below the earlier forecast range of 11.5 – 13.5 percent. However, this assessment is contingent on achieving the targeted fiscal consolidation and timely realization of planned external inflows.

The State Bank of Pakistan Monetary Policy Committee (MPC) on Monday reduced the policy rate by 150 bps to 20.5 percent, effective from June 11, 2024.

The MPC noted that while the significant decline in inflation since February was broadly in line with expectations, the May outturn was better than anticipated earlier.

The Committee assessed that underlying inflationary pressures are also subsiding amidst tight monetary policy stance, supported by fiscal consolidation.

This is reflected by continued moderation in core inflation and ease in inflation expectations of both consumers and businesses in the latest surveys.

At the same time, the MPC viewed some upside risks to the near-term inflation outlook associated with the upcoming budgetary measures and uncertainty regarding future energy price adjustments.

Notwithstanding these risks and today’s decision, the Committee noted that the cumulative impact of the earlier monetary tightening is expected to keep inflationary pressures in check.

The MPC noted the following key developments since its last meeting. First, real GDP growth remained moderate at 2.4 percent in FY24 as per provisional data, with subdued recovery in industry and services partially offsetting the strong growth in agriculture.

Second, a reduction in the current account deficit has helped improve the FX reserves to around US$9 billion despite large debt repayments and weak official inflows.

The government has also approached the IMF for an Extended Fund Facility program, which is likely to unlock financial inflows that will help in further build-up of FX buffers. Lastly, international oil prices have declined, whereas non-oil commodity prices have continued to inch up.

Based on these developments, the Committee, on balance, viewed that it is now an appropriate time to reduce the policy rate.

The Committee noted that the real interest rate still remains significantly positive, which is important to continue guiding inflation to the medium-term target of 5 – 7 percent. The Committee also emphasized that the future monetary policy decisions will remain data-driven and responsive to evolving developments related to the inflation outlook.

Latest estimates indicate real GDP growth at 2.1 percent in Q3-FY24 against a contraction of 1.1 percent in the same quarter last year. While agriculture was already showing strong growth, industry also witnessed positive growth in Q3. Also, initial growth estimates for both Q1 and Q2 for FY24 were revised upward.

Taking into account the developments in the first nine months, FY24 growth is provisionally estimated by PBS at 2.4 percent against a contraction of 0.2 percent in FY23. Almost two-thirds of this recovery was explained by improvement in the agriculture sector. These developments are in line with the MPC’s earlier expectations. For FY25, the MPC expects economic growth to remain moderate.

This assessment takes into account the impact of expected moderation in agriculture output and ongoing stabilization policies.

The current account posted a surplus for the third consecutive month in April on the back of robust growth in remittances and exports, which more than offset the uptick in imports. During July-April FY24, the current account deficit narrowed significantly to $202 million. In the same period, exports grew by 10.6 percent, mainly driven by increased quantum of rice and HVA textile exports.

Conversely, imports decreased by 5.3 percent during the same period due to lower international commodity prices, better domestic agriculture output and moderate economic activity. Workers’ remittances also remained robust in recent months, reaching an all-time high of $3.2 billion in May 2024.

The resultant lower current account deficit, along with improved FDI and the disbursement of SBA tranche in April, has facilitated ongoing large debt repayments and supported the SBP’s FX reserves. Going forward, the Committee stressed that timely mobilization of financial inflows is essential to meet the external financing requirements and further strengthen FX buffers for the country to effectively respond to any external shocks and support sustainable economic growth.

Fiscal indictors continued to show improvement during July-March FY24. The primary surplus increased to 1.5 percent of GDP, while the overall deficit remained almost at last year’s level.

A large part of this improvement reflected the impact of increase in tax and PDL rates, higher SBP profit, and lower energy sector subsidies. Considering there has been limited progress in addressing the structural weaknesses to broaden the tax base and initiate energy sector reforms, FY25 budgetary measures are also expected to be largely rate-based. In this backdrop, the Committee emphasized that fiscal consolidation through broadening the tax base and reforming loss-making public sector enterprises would help achieve fiscal sustainability on a more durable basis.

This is also imperative to keep inflation on a downward trajectory and contain external account pressures.

Money and credit

The broad money (M2) growth decelerated to 15.2 percent y/y on May 24, 2024 from 17.1 percent as of end-March 2024.

This reduction was primarily due to deceleration in growth of net domestic assets of the banking system. On the other hand, the growth contribution of net foreign assets in M2 remained positive. From the liability side, deposits remained the mainstay in M2 growth, while currency in circulation growth decelerated. As a result, reserve money growth observed a steep decline from 10.0 percent to 4.3 percent during the period.

The MPC noted that these developments in monetary aggregates are consistent with the tight monetary policy stance and have favorable implications for the inflation outlook.

Inflation outlook

Headline inflation decelerated to 11.8 percent in May 2024 from 17.3 percent in April. Besides the continued tight monetary policy stance, this sharp reduction was also driven by a sizeable decline in prices of wheat, wheat flour, and some other major food items, along with the downward adjustment in administered energy prices. Core inflation also decelerated to 14.2 percent from 15.6 percent.

The Committee noted that the near-term inflation outlook is susceptible to risks emanating from the FY25 budgetary measures and future adjustments in electricity and gas tariffs. The MPC foresees a risk of inflation to rise significantly in July 2024 from current levels, before trending down gradually during FY25.

The MPC also observed that sharp wheat price reductions have historically proved to be temporary. On balance, the Committee assessed that the current monetary policy stance remains appropriate to ensure that inflation stays on a downward trajectory.