Central bank says favourable trends in global commodity prices, lower inflation and limited damage from recent floods led to decision
As expected, the State Bank of Pakistan (SBP) on Saturday reduced its key policy rate by 50 basis points to 9.5 per cent until mid-January.
The bank said favourable trends in global commodity prices, lower inflation and limited damage from recent floods were the main reasons behind the decision.
The decision was taken by the central board of directors of SBP at its meeting held under the chairmanship of Governor Ashraf Mahmood Wathra.
The meeting observed that CPI inflation (YoY) in October, 2014 has come down sharply to 5.8 per cent.
“This decline is explained by: smooth food supplies, which contained the price of perishable items; falling administered prices, which incorporate the fall in international commodity prices, especially oil; low inflation expectations, as witnessed by IBA-SBP consumer confidence surveys; and a significant base effect,” said a SBP statement.
Pakistan last week almost qualified for the release of a $1.1 billion instalment from an International Monetary Fund (IMF) facility despite political turmoil and recent floods.
After two weeks of talks with the Pakistani finance minister and officials in Dubai last week, the IMF had said it was encouraged by the strong fiscal performance achieved during the year 2013-14.
The IMF mission will submit its report to the IMF Executive Board in December to conclude two more reviews, after which $1.1 billion will be made available to Pakistan upon board approval.
The IMF granted an extended fund facility to cash-strapped Pakistan in September 2013 on the condition that it carry out extensive economic reforms especially in energy and taxation sectors
Given its recent downward trend, the SBP said the likelihood for inflation to end in the current fiscal year on a lower plateau was high. But there are risks, the regulator warned.
Firstly, downward trend over medium to long term remained to be seen because it was based on volatile prices of “perishable items” and “oil”.
Secondly, other risks identified such as cut in subsidy to electricity and levying of Gas Infrastructure Development Cess (GIDC) still held and if materialised can alter the inflation outlook on a higher side. Thirdly, underlying inflationary pressures on core inflation remained.
The current low oil price could salvage some of the lost growth momentum, the central bank said.
Broadly, however, growth in Large Scale Manufacturing (LSM) would remain constrained due to energy bottlenecks. Thus, the main thrust to the growth momentum would come from agriculture outcomes in the remaining months of FY15.
Barring the limited flood-related damage to some Khariff crops, agriculture output was expected to perform better than the previous year, especially now when incentive for Rabbi season crops had been announced. Like, SBP said, the recent increase of Rs 100 in wheat support price.
The central bank was appreciative of the government that, it said, had shown a significant progress in curtailing budgetary imbalances.
“It seems on course to achieve further fiscal consolidation, given its current management of expenditures and borrowing pattern,” it viewed.
This, the bank observed, had positive implications for the monetary management of the SBP and more importantly, in the coming months, it would have a favourable impact on the private sector credit cycle.
However, the bank said, structural reforms to broaden the tax base was imperative to achieve fiscal consolidation in the long run.
Low oil prices along with falling inflation could improve competitiveness of Pakistani exports. Imports, on the other hand, might take advantage of low global commodity prices and increase further in the rest of FY15. This could add to exports competitiveness and improve its outlook towards the end of the current fiscal year.
In the meantime, current slowdown in exports was further challenged by falling international cotton prices and stiff competition in low value-added textile products in an environment of weak global demand.
“Thus, trade deficit is expected to remain under pressure and the healthy growth in workers’ remittances would continue to assuage the weaknesses in current account deficit, to some extent,” the SBP said.
It is also important to note the role of foreign exchange inflows in domestic liquidity creation and helping the banks to extend more credit to the private sector.
“This happens as government gets the space to borrow less from the banks, thereby leaving more liquidity with the banks for credit expansion.”
In response to various recent and ongoing efforts of the government, foreign exchange inflows would remain on track, the SBP said.
