KARACHI - The State Bank of Pakistan has decided to reduce the policy rate by 50 basis points (bps) to 9.5 percent.
The decision was taken by the Central Board of Directors of SBP at its meeting held under the chairmanship of Governor Ashraf Mahmood Wathra in Karachi on Saturday.
Limited impact of floods and a favourable trend in global commodity prices are the major highlights of the post-September monetary policy decision. Indeed, CPI inflation (YoY) in October 2014 has come down sharply to 5.8 percent.
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. These developments bode well for the better outlook of other macroeconomic variables in general.
Given its recent downward trend, the likelihood for inflation to end the current fiscal year on a lower plateau is high. But, there are some risks as well. Firstly, the downward trend is based on volatile prices of ‘perishable items’ and ‘oil’. Secondly, other risks identified in the previous statement such as cut in subsidy to electricity and levying of Gas Infrastructure Development Cess still hold and if materialised can alter the inflation outlook on a higher side. Thirdly, there are underlying inflationary pressures on core inflation too.
The prevailing low oil prices can salvage some of the lost growth momentum. However, the energy bottlenecks would go on hindering the growth of large-scale manufacturing sector. Thus the main thrust to the growth momentum would come from agriculture in the remaining months of FY 2014-15. Due to the limited flood-related damage to some kharif crops, agriculture output is expected to perform better than the previous year, especially after the incentives announced by the government for Rabbi crops including recent increase of Rs100 in wheat support price.
Government has 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. This has 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, to achieve fiscal consolidation in the long run structural reforms will have to be introduced to broaden the tax base.
Low oil price along with falling inflation can 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 FY14-15. In the meantime, current slowdown in exports is 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 role of foreign exchange inflows in domestic liquidity creation is vital it helps the banks to extend more credit to the private sector. This happens when government gets some space to borrow less from the banks, thereby leaving more liquidity with the banks for credit expansion. Due to various recent and ongoing efforts of the government, foreign exchange inflows would remain on track.
Based on these considerations, the Board of Directors of the State Bank of Pakistan, has decided to reduce the policy rate by 50 basis points to 9.5 percent with effect from 17th November, 2014.