Monetary easing amid economic recovery efforts

In a series of bold monetary policy decisions, the State Bank of Pakistan (SBP) has continued its aggressive interest rate cuts, aiming to stimulate the country’s economic recovery. With external debt repayments looming and inflationary pressures easing, the central bank has made significant moves to bolster growth, stabilize the balance of payments, and improve macroeconomic stability.
In a bold and unanticipated maneuver, the central bank slashed its primary policy rate by a substantial 200 basis points, bringing it down to 17.5%. This marks the third successive reduction since June, surpassing forecasts. The strategic cut is designed to invigorate economic momentum, with authorities aiming to catalyze growth as inflation shows signs of abating.
The recent rapid “disinflation,” driven by delayed hikes in energy tariffs and declining global prices of oil and food, afforded the State Bank of Pakistan (SBP) the latitude to implement this pronounced 200 basis point reduction. Public sentiment had largely anticipated a smaller decrease of 150 basis points, as inflation dropped to single digits in August, the first time this has occurred in almost three years.
This latest adjustment follows earlier reductions of 150 basis points in June and 100 basis points in July, cumulatively bringing the rate down from its peak of 22% in June 2023, a level that had been maintained for an entire year. Despite this sequence of rate cuts over the past three months, the central bank underscored that it remains committed to a “tight monetary stance.” It continues to maintain a significant real interest rate, between 7.5% and 8%, by preserving a wide differential between the prevailing policy rate and the most recent consumer price index (CPI) inflation figure.
Annual consumer price inflation decelerated to 9.6% in August, a sharp decline from the multi-decade high of nearly 40% recorded in May 2023. This decline provides the SBP with additional leeway to buffer against any unexpected inflationary spikes, as it expects economic growth to reach the upper range of its forecast, between 2.5% and 3.5%, for the current fiscal year.
The bank’s Monetary Policy Committee (MPC) indicated that there is potential for average inflation in FY25 to fall below the previously projected range of 11.5% to 13.5%. Meanwhile, the governor of the SBP noted that the government has secured over $2 billion in external financing to address a funding gap required to meet IMF conditions. He expressed confidence that the IMF Executive Board would approve the Extended Fund Facility (EFF) by September.
The EFF approval is anticipated to unlock additional financial inflows, stabilizing the balance of payments and ensuring no further shortfalls. Furthermore, the central bank projects foreign exchange reserves to climb to $12 billion by March 2025.
Additionally, Pakistan is set to face maturing external debt amounting to $14.1 billion between September 2024 and March 2025. Of this total, $8.3 billion is anticipated to be rolled over, leaving a net repayment obligation of $5.8 billion—an average monthly payment ranging from $800 million to $1 billion. From July 2024 until now, the country has already addressed $4 billion in external debt obligations, with $2.3 billion rolled over and $1.7 billion repaid.
The SBP has continued its aggressive monetary easing, enacting a third consecutive rate cut over the past three months. This has led to a cumulative reduction of 450 basis points. Previously, the central bank had held its policy rate at a record 22% for a year, from June 2023 to June 2024.
Looking ahead, the monetary policy statement predicts an uptick in “import volumes,” driven by the ongoing domestic economic recovery. However, improvements in Pakistan’s terms of trade, largely due to a decline in crude oil prices, are expected to limit the overall trade deficit in FY25. Stable export earnings are also anticipated, with growth in high-value-added textiles projected to counterbalance any expected reduction in rice exports.
The SBP highlighted that these trends, alongside robust workers’ remittances, are likely to keep the current account deficit within a manageable range of 0-1% of GDP in FY25. This, combined with the anticipated realization of inflows under the IMF program, should further bolster the SBP’s foreign exchange reserves.
During the first two months of FY25 (July-August), the Federal Board of Revenue (FBR) recorded a 20.5% growth in tax collection. However, the Monetary Policy Committee (MPC) stressed that this growth must accelerate significantly in the coming months to meet the fiscal year’s revenue targets.
The report noted that fiscal consolidation achieved over recent years has bolstered monetary policy efforts to reduce inflation and restore overall macroeconomic stability. The real interest rate is deemed sufficiently positive to continue bringing inflation down to the medium-term target range of 5-7%, ensuring macroeconomic stability—a key factor for achieving sustainable economic growth in the medium term.
On a positive note, the committee pointed out that easing inflationary pressures and the effects of recent interest rate cuts are expected to boost growth in the “industry and services sectors.” However, the outlook for the agricultural sector appears less optimistic. This downturn is largely due to an anticipated shortfall in cotton production, falling short of the government’s targets. The shortfall is attributed to reduced cultivation area and a significant decline in cotton arrivals by the end of August 2024.
As Pakistan’s economy faces both challenges and opportunities, the SBP’s recent actions to reduce the interest rate, while maintaining a firm stance on inflation control, highlight its commitment to balancing growth with stability. With improving terms of trade, steady remittances, and external debt management in place, the country is poised to benefit from these measures. However, concerns remain regarding the agriculture sector, and the pace of tax collection needs to increase to meet fiscal goals. Nonetheless, with strategic policy adjustments and continued fiscal consolidation, Pakistan aims to ensure sustainable economic growth in the coming years.