Pakistan’s State Bank of Pakistan recently reduced the benchmark policy rate by a big 2.5 percentage points, becoming the fourth consecutive rate cut since June that took it to a two-year low. The move goes hand in hand with faster-than-expected falling inflation targeting to stimulate activity and growth that exceeded 2.5% last fiscal year.

The rate cut, more than the market’s expectations, also chimes with the central bank’s strategy of moderating the current account deficit, encouraging imports, and easing financial conditions for businesses. This latest cut is a 7-point reduction in the policy rate over the past five months, which is impressively relieving the interest burden on the national debt to the tune of Rs1.3 trillion or 1% of GDP for the current fiscal year as against the originally targeted sum of Rs9.3 trillion.

So, as we get $500 million inflow from the ADB, our foreign exchange reserves will boost to $11.7 billion,” said Pakistan SBP Governor Jameel Ahmad at a briefing to analysts after the monetary policy announcement. Remittances from overseas Pakistanis, or overall remittance inflows, are also likely to breach $3 billion in October, slightly up from a $3 billion monthly average of July to September in fiscal 2024-25. The current account is likely to remain balanced because of strong remittances, which it has so far for the first quarter of the fiscal year.

The SBP noted in its latest MPS that agricultural output for the current Kharif season has come in better than expected. Rice and sugarcane yields have more than compensated for the shortfall in maize and cotton. Reiterating its earlier growth projection of FY25 at 2.5-3.5%, the SBP bases the rate cut on the fact that disinflation in the economy takes place at a pace steeper than anticipated, as inflation dips into the desired range of 5-7% in the medium term. Inflation was 6.9% in September and 7.2% in October. Low global oil prices, reduced food inflation, stable gas tariffs, and petroleum levies would further support the downward momentum of inflation. However, short-term inflation may still move up and down and stabilize in the target range of 5-7%.

That has enabled the State Bank of Pakistan to aggressively cut policy rates by a bold 2.5 percentage points to support business activity, pushing more rapid economic growth that could well be higher than the 2.5% witnessed in FY24. A lot more aggressive than market expectations that had priced in a two-point cut. It’s also the fourth straight policy rate cut since June this year.

The SBP reported a secular rise in imports due to the softened monetary stance, and it expected further liberalization in imports during the year while keeping them affordable. This trend will see the current account deficit contained between 0-1% of GDP in the fiscal year.

“The latest data show a steady increase in economic activity,” the SBP noted, suggesting that major Kharif crops performed well and crossed the initial forecast. In industrial activities, the state of affairs is also looking good as textile and food sectors have expanded with considerable growth during July-August 2024, and further expansion is expected.

This may be matched by better business sentiment, easier financial conditions, and growing imports of raw materials and machinery. Inflation pressures are likely to abate while favorable commodity-producing sector conditions are expected to buoy the services sector.

The SBP sees average inflation for FY25 coming in much lower than its previous 11.5-13.5% estimate, but it cautioned that several risks remain, including those stemming from Middle East tensions, a reprise in the ratcheting up of food prices, and any spillover hikes in administered energy costs or other tax measures to fill revenue holes.

Remittances are likely to be stronger than the exports, but the planned official inflows are likely to keep SBP’s foreign exchange reserve close to $13 billion by June next year. Repayment and interest repayment obligation of Pakistan for FY25 amounts to $26.1 billion of which amount has been already paid, with $2.3 billion rollover. More rollovers are expected at $14.1bn, which leaves a net repayable balance of $6.3bn.

The net profit of the SBP from FY24 is Rs4 trillion. This puts Rs2.7 trillion at the disposal of the government. This has also reduced the share of short-term domestic debt (T-bills) in the total domestic debt from 24pc to 21pc. These short-term domestic debts are likely to drop below 20pc by the end of FY25.

Aggressive cuts from the combined powers of policy change by the SBP and stronger remittances can offer ways to stabilize the economy of Pakistan, while improved agricultural and industrial output are on the anvil. Reduction in home debt and positive forecast in foreign reserves only provides a strengthened fiscal outlook of the coming year. Yet, geopolitical tensions amongst risks such as inflationary pressures can dampen the optimistic outlook of the bank.