The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) has made the decision to maintain the policy rate at 22% in its recent meeting. This Committee’s move aligns with market expectations, as most market participants anticipated a rate hold. The MPC observed that headline inflation, as anticipated, increased in September 2023 but is expected to decrease in October and continue on a downward trajectory, particularly in the second half of the fiscal year.
However, the MPC acknowledged several factors that could impact the inflation and current account outlook for FY24. These factors include recent volatility in global oil prices and the impending increase in gas tariffs from November 2023. Nonetheless, there are offsetting factors to consider, such as targeted fiscal consolidation in Q1, improvements in the availability of essential commodities, and the alignment of interbank and open market exchange rates.
The MPC pointed out some key developments since its September meeting. Firstly, there are encouraging initial estimates for Kharif crops, which are expected to have positive effects on various sectors of the economy. Second, the current account deficit significantly narrowed in August and September, contributing to the stabilization of SBP’s foreign exchange reserves despite limited external financing. Third, fiscal consolidation efforts are on track, with both fiscal and primary balances improving during Q1-FY24. Fourth, while core inflation remains persistent, inflation expectations among consumers and businesses have improved.
Nevertheless, the global oil price volatility and the ongoing conflict in the Middle East introduce uncertainty into the economic landscape. Given these circumstances, the MPC emphasized the importance of maintaining a tight monetary policy stance.
The MPC reiterated its earlier view that the real policy rate remains significantly positive on a 12-month forward-looking basis. This stance is considered appropriate to bring inflation down to the medium-term target of 5-7% by the end of FY25. However, this outlook depends on continued fiscal consolidation and the timely realization of planned external inflows.
On the real sector front, recent data indicates moderate economic growth for the year, with favorable estimates for Kharif crops and a recovery in key sectors like cement, petroleum, oil, and auto sales. Large-scale manufacturing (LSM) output is gradually improving, primarily driven by domestic-oriented sectors.
In terms of the external sector, the MPC observed a substantial improvement in the current account balance, with the deficit narrowing significantly. Exports and workers’ remittances improved in September, and reforms related to exchange companies have contributed to better FX market sentiments and liquidity.
Fiscal indicators improved during Q1-FY24 compared to the previous fiscal year. The fiscal deficit and primary balance both showed improvement, reflecting increased revenue collection and reduced spending. Continued fiscal prudence is considered crucial for keeping inflation on a downward trajectory.
In the money and credit sector, broad money (M2) growth decelerated due to a slowdown in private sector credit and commodity operations financing. The MPC noted changes in the composition of both M2 and reserve money, which are expected to improve with fiscal consolidation and expected external inflows.
In terms of the inflation outlook, headline inflation surged in September but is expected to decrease in October due to adjustments in fuel prices, easing food commodity prices, and a favorable base effect. However, global oil price trends and increased gas tariffs pose some upside risk to the inflation outlook, and core inflation remains elevated. Fiscal policy and the availability of food commodities are expected to complement the central bank’s efforts to reduce inflation.
Overall, the MPC’s decision to maintain the policy rate reflects its commitment to managing inflation and stabilizing the economy, taking into account various domestic and global factors.
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