In a strategic move to bolster economic growth, Pakistan’s central bank has slashed its key policy rate by 100 basis points, bringing it down to a 16-month low of 19.5%. This reduction aims to stimulate economic expansion within the range of 2.5-3.5% for the current fiscal year.

The State Bank of Pakistan (SBP) has now lowered the policy rate for the second time in just seven weeks, reflecting a response to slowing inflation and a strengthening external economy. Notably, the country’s foreign exchange reserves currently stand at $9.1 billion, slightly higher than the $9 billion in net foreign debt repayments due in FY25, indicating that Pakistan is not facing an imminent foreign debt repayment crisis this year.

Over the past seven weeks, the SBP has cumulatively reduced the policy rate by 250 basis points, a notable shift from the record high of 22% maintained until June 10, 2024. The initial cut of 150 basis points, the first in three years, was implemented early last month. During a press conference, SBP Governor Jameel Ahmad explained that the effects of the central bank’s previously stringent monetary policy have only recently begun to take hold, as changes in the policy rate typically take about eight quarters to fully manifest.

The SBP Governor projected economic growth to rise between 2.5-3.5% in FY25, compared to the 2.4% growth achieved in FY24, driven by a resurgence in agricultural output. He highlighted that Pakistan is set to repay only $9 billion in foreign debt over the next 11 months of FY25, slightly less than the current foreign exchange reserves held by the SBP, indicating the country is well-prepared to manage its external debt repayments, thereby resolving the balance of payments crisis.

Moreover, he forecast an increase in foreign exchange reserves by a net $4 billion, reaching $13 billion by the end of the fiscal year on June 30, 2025. This anticipated growth is expected to be partly achieved through purchasing surplus US dollars from domestic currency markets. He also noted that inflows of workers’ remittances from overseas Pakistanis remained strong in July 2024, exceeding the average monthly receipts of FY24, which were recorded at $2.52 billion per month.

The SBP Governor estimated that inflation would significantly decrease to 11.5-13.5% in FY25, down from 23.4% in FY24, thus supporting economic growth throughout the year. Additionally, the country’s current account deficit (CAD) is projected to remain moderate, ranging from zero to 1% of GDP (less than $4 billion) in FY25, compared to 0.2% of GDP ($681 million) in FY24.

Despite a notable increase in the monthly import of goods to $4.9 billion in June 2024, up from $3.5 billion a year ago, the expected continued rise in export earnings and inflows of workers’ remittances are anticipated to enable banks to finance necessary imports. This marks a significant shift from previously controlled market conditions to a fully liberalized one in the recent past. He also stated that Pakistan has successfully cleared the backlog of profit and dividend repatriations by foreign companies operating in the country to their headquarters abroad. Multinational companies (MNCs) have repatriated profits and dividends amounting to $2.2 billion in FY24, a sevenfold increase compared to the $300 million sent in FY23 when there were restrictions due to low foreign exchange reserves.

Regarding foreign debt repayments, he provided detailed insights, revealing that Pakistan is set to repay a total of $26.2 billion in principal and interest payments for FY25, compared to $24.5 billion in FY24. He noted that Pakistan has already settled $3.1 billion in repayments in the first month of FY25 (July 2024) through rolling over $2 billion and repaying $1.1 billion. For the remaining 11 months of FY25, the country is expected to repay $9 billion (including interest payments) and is anticipated to secure rollovers for the remaining $14.1 billion in bilateral debt from friendly countries and commercial loans.

The SBP’s Monetary Policy Committee (MPC) justified the recent policy rate reduction by citing June 2024’s inflation reading of 12.6%, which was “slightly better than anticipated.” The MPC also noted that the inflationary impact of the FY25 budgetary measures was largely in line with earlier expectations. The significantly positive real interest rate provided room for this latest policy rate cut. Despite the reduction, the MPC emphasized that the monetary policy stance remains tight to guide inflation toward the medium-term target of 5-7%. This outlook depends on achieving targeted fiscal consolidation, timely realization of planned external inflows, and addressing underlying structural weaknesses in the economy through reforms.

The second consecutive rate cut by the SBP highlights the central bank’s optimism about a slower but stable recovery, expecting the economy to build upon the gains of last year’s stabilization policies. The decision to cut the policy rate by 100 basis points, following an earlier reduction of 150 basis points in June to 19.5%, appears driven by declining inflation, a narrowing current account deficit, the build-up of reserves despite substantial debt and other repayments, and a preliminary agreement with the IMF for a $7 billion loan. The SBP is hopeful that its reserves will grow from above $9 billion to $13 billion by the end of this financial year, bolstered by a manageable current account and anticipated foreign official and private flows. Monetary authorities also believe that the accumulation of reserves has created space for further rate reductions to support growth while keeping inflation in check, as “the monetary policy stance still remains sufficiently stringent to steer inflation toward the medium-term target of 5-7%.” However, the continuation of monetary easing is contingent on fiscal consolidation, realization of planned external flows, and structural reforms addressing the economy’s underlying weaknesses.

Fitch has upgraded Pakistan’s sovereign credit rating by a notch from ‘CCC’ to ‘CCC+’, citing easing external funding risks and improvements in the current account. The new Fitch rating suggests that the immediate danger of Pakistan defaulting is over, although significant risks remain. The improved credit rating can help Pakistan raise international debt to shore up its reserves and reduce borrowing costs through instruments like Eurobonds and Panda bonds, though investors might demand higher returns. These two developments are positive signs of economic stabilization. However, there is still a long way to go before the economy is back on a faster growth trajectory. With the economy expected to remain fragile and in low growth mode due to the implementation of the stabilization policy, the next three years will not be easy for the people. Policymakers may take solace in the IMF loan and better credit rating, but they must recognize that there is no room left to backtrack on their commitment to reform.

The SBP’s decision to cut the policy rate underscores a cautiously optimistic outlook for Pakistan’s economic recovery. With declining inflation, a narrowing current account deficit, and bolstered reserves, the central bank envisions a stable yet gradual economic expansion. The recent upgrade in Pakistan’s credit rating by Fitch to ‘CCC+’ further supports this optimistic narrative, providing opportunities to raise international debt and potentially reduce borrowing costs. However, the path ahead remains challenging, requiring steadfast commitment to fiscal consolidation, structural reforms, and prudent economic management to ensure sustainable growth and stability.