In the May MPS, the State Bank of Pakistan (SBP) has cut the policy rate by 100bps to 8.0%, bringing the cumulative reduction since mid-March 2020 to 525bps. This was a scheduled meeting and the move is broadly in-line with market expectations. Real interest rates now stand at zero going by the mid-level of SBP’s projected range for FY21 inflation of 7-9%.
Key reasons behind the decision:
The recent reduction in petroleum (POL) prices by 30-40% supports the view that disinflation in future will be greater than expected. Inflation in FY21 is expected to average towards the lower-end of the indicated range of 7-9%. CPI in April clocked in at 8.5% yoy vs. an average of 11.5% in the previous 9mths.
The lockdown situation has greatly disrupted economic activity in Pakistan. In this environment the policy rate cuts serve to provide immediate liquidity to households and businesses. This has been complemented by recent measures by the SBP to provide cheap loans via refinancing facilities to maintain credit flows, prevent insolvencies and contain unemployment.
The pressure on the external account remains manageable, where the external debt relief and still-modest C/A balance have maintained the SBP’s Forex reserves at c.US$12.0bn (better than 3mth import cover). Given receding inflation and a contracting economy, this has encouraged further monetary easing. C/A deficit shrunk 73% yoy to US$2.8bn in 10MFY20.
High-frequency indicators of demand such as credit card spending, cement dispatches, credit off-take and POL sales have witnessed a marked contraction during March-April 2020. Further, the MPC has noted that although phased lifting of restrictions for different sectors may lead to a pick-up in economic activity, preliminary evidence (from China and other countries which initiated the easing of lockdowns) suggests that a rebound in service sectors and consumption, which form a large part of the domestic economy, could remain sluggish for longer.
The MPC was also emboldened by the encouragement from international agencies, including the IMF, to ramp up monetary and fiscal stimulus in the present environment.
The SBP highlighted that the cumulative interest rate cut in Pakistan has been greater than in other Emerging countries, and this has been supported by greater disinflation than seen in the same group. Future monetary policies will continue to be driven by the pandemic situation in Pakistan; where a worse-than-expected transmission rate and increased lockdown conditions would likely lead to further cuts in the policy rate.