The State Bank of Pakistan (SBP) announced on Monday that it had reduced the key policy rate by 100 basis points to 12 percent, effective January 28, 2025.
This marks the sixth rate cut since June 2024, bringing the policy rate down by a cumulative 1,000 basis points from 22 percent. In a press conference, SBP Governor Jameel Ahmed explained the decision taken by the Monetary Policy Committee (MPC) earlier in the day. He said the reduction was made with the inflation outlook in mind and noted several positive trends in the economy.
“The current inflation numbers are encouraging, and we expect further declines in January,” the governor said. However, he cautioned that core inflation remains high.
He also highlighted a positive trend in remittances and foreign exchange reserves, saying, “We maintain our outlook to achieve $13 billion in reserves by June.”
Ahmed noted an improvement in exports and remittances, which had kept the current account in a positive position. “The trend in remittances is good, and so are export numbers, which is important for maintaining the current account surplus,” he stated.
What does it mean for the economy?
A lower borrowing costs can stimulate investment and consumption, driving economic recovery and supporting high-leverage and consumer-focused industries.
For the common man, such decisions have a ripple effect on everyday life. A reduction in interest rates, as seen with a cumulative 1000 basis point cut this fiscal year, offers relief for borrowers. Lower borrowing costs make it easier for individuals to finance homes, vehicles, or education while enabling businesses to expand. However, for savers, the returns on deposits may decline, prompting shifts toward alternative investments, seeing a rise in economic activity. This, in fact, was one of the main reasons for the increase in PSX investing in the last couple of months.
In its analyst briefing, the SBP also highlighted that external debt repayment pressures will ease in the second half of FY25. With $6.4 billion already repaid and net repayments reduced to $3.6 billion, there’s less strain on foreign exchange reserves. Expected inflows from commercial banks and bilateral arrangements are projected to offset these outflows, ensuring stability in the country’s foreign exchange reserves. This stability is crucial for import-dependent sectors and impacts the prices of fuel, electronics, and other imported goods that affect household budgets.
Sectoral impacts of monetary policy cuts are particularly pronounced. High-leverage industries like textiles, steel, and cement stand to gain from lower financing costs, potentially boosting economic activity and employment. Consumer-focused industries, such as autos, may benefit from improved consumer financing options, translating to greater accessibility for middle-class buyers.
Meanwhile central bank profits may dip due to falling interest rates, better yields on foreign exchange portfolios could cushion some of the impact. Ultimately, cautious monetary policy aims to strike a balance between economic growth, inflation control, and financial stability, all of which directly affect the quality of life for citizens.
The Monetary Policy Statement:
The SBP’s Monetary Policy Statement confirmed that inflation reached 4.1 percent year-on-year in December, down from 4.9 percent in November. The statement attributed the downward trend to moderated domestic demand, stable supply-side conditions, and a favourable base effect. However, it warned that core inflation pressures persist and that inflation is expected to inch up in the coming months.
The MPC noted several developments since its last meeting. Real GDP growth for Q1-FY25 came in slightly below expectations at 0.9 percent, down from 2.3 percent in Q1-FY24, largely due to slower agriculture sector growth.
The current account posted a $0.6 billion surplus in December, bringing the H1-FY25 surplus to $1.2 billion, supported by strong remittances and export earnings. However, tax revenues, despite a notable increase in December, remained below target in H1-FY25, and global oil prices showed volatility, adding to economic uncertainty.
The SBP governor also addressed the recent adjustments in treasury bill rates, which had been reduced by up to 41 basis points in the last auction. This move reflected market expectations of a policy rate cut. Financial analysts had widely anticipated the 100 basis points reduction announced by the MPC.
The statement further noted that the slowdown in large-scale manufacturing (LSM) had moderated, with some key industrial sectors such as textiles and automobiles showing improvement. However, provisional GDP data for Q1-FY25 indicated a deceleration in agriculture sector growth, which stood at 1.2 percent compared to 8.1 percent in the same period last year.
On the external front, the SBP highlighted strong export performance led by high-value-added textiles and broad-based acceleration in imports. While the import bill outpaced export earnings, robust remittance inflows helped offset the trade deficit.
The current account balance is now expected to remain between a small surplus and a deficit of 0.5 percent of GDP for FY25.
On fiscal performance, the SBP noted a 26 percent year-on-year increase in FBR revenues during H1-FY25, though the shortfall from the target widened. It observed that relatively contained expenditures, coupled with lower interest payments, were likely to keep the fiscal deficit around its target.
The central bank reported that money supply growth had decelerated, driven by lower net domestic asset growth and a shift in government borrowing to non-bank sources. Despite the slowdown, private sector credit grew sharply, reflecting an ongoing economic recovery and efforts by banks to meet advances-to-deposit ratio (ADR) thresholds.
In conclusion, the SBP noted that inflation is expected to average between 5.5 and 7.5 percent for FY25. The MPC emphasised that the monetary policy stance will remain cautious to ensure price stability and sustainable economic growth. Ahmed reiterated that the central bank will continue to monitor economic trends closely and adjust its policies accordingly.
