KARACHI: The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP), in its emergent meeting held on Thursday, decided to further cut the key policy rate by 100 basis points (bps) to 7 percent aimed to address the domestic economic slowdown due to the Covid-19 pandemic.
MPC slashed policy rate fifth time since the Covid-19 [pandemic began to spread through the country in March. The current decision brings the cumulative reduction in the policy rate since mid-March to 625 basis points from 13.25 to 7 percent, commensurate with the decline in inflation during this period. Now the key policy rate has reached the lowest level of the last two years.
The committee observed that the take-up of several other SBP initiatives has risen significantly in recent weeks, notably concessional refinancing facilities to protect employment and support the health sector as well as regulatory measures to provide debt servicing relief. Together, this strong and data-driven monetary policy response should support growth and employment, while keeping inflation expectations anchored and maintaining financial stability.
Looking ahead, during the meeting it was estimated the economy is expected to recover gradually in FY21, supported by easing lockdowns, supportive macroeconomic policies and a pick-up in global growth. However, risks are skewed to the downside and the recovery will depend critically on the evolution of the COVID-19 pandemic both in Pakistan and abroad.
According to monetary policy statement issued after the meeting, this rate cut decision reflected the MPC's view that the inflation outlook has improved further, however, the domestic economic slowdown continues and downside risks to growth have increased. Against this backdrop of receding demand-side inflation risks, the priority of monetary policy has appropriately shifted toward supporting growth and employment during these challenging times.
Consistent with its mandate, the MPC re-asserted its commitment to supporting households and businesses through the Covid-19 crisis and minimizing damage to the economy. In this context, the MPC felt that from a risk management point of view, a prompt response to downside risks to growth was called for given the improved inflation outlook.
In addition, the MPC noted that with approximately Rs 3.3 trillion worth of loans due to be re-priced by early July 2020, this was an opportune moment to take action from a monetary policy transmission perspective. In this way, the benefits of interest rate reductions would be passed on in a timely manner to households and businesses.
The Covid-19 pandemic is spreading in many emerging markets, including Pakistan, and there are fears of a second wave in several other countries. The MPC observed that risks to the global outlook are heavily skewed to the downside and the path of recovery remains uncertain.
The update of the World Economic Outlook (WEO) released on Wednesday, the IMF downgraded its 2020 global growth forecast further to -4.9 percent, 1.9 percentage points lower than in April, and projected a more gradual recovery than previously anticipated.
The Committee believed the inflation outlook has improved further and the FY2020-21 budget is also expected to be neutral for inflation as the freeze on government salaries, absence of new taxes, and lower production cost from reduced import duties should offset the decline in subsidies in some sectors.
Domestically, the moderation of underlying inflation has continued. Notwithstanding a seasonal uptick in food prices associated with the Eid holiday, headline inflation declined further to 8.2 percent in May on the back of the recent cut in diesel and petrol prices.
In addition, month-on-month inflation rates continue to be low. Recent SPI data also suggests continued moderation in overall price pressures in June, despite increases in prices of some food items, notably wheat.
While supply shocks could create some volatility in inflation, the MPC felt that these are likely to be transitory given weak domestic demand, such that monetary policy should generally look past them.
Given the absence of demand-side pressures, average inflation could fall below the previously announced range of 7-9 percent for next fiscal year. With the current reduction of the policy rate to 7 percent, the MPC felt that real rates on a forward-looking basis (defined as the policy rate less expected inflation) would be kept close to zero, which is appropriate under the current circumstances.
During this period of external volatility, the MPC observed that the flexible exchange rate has played its valuable shock absorber role, helping cushion the economy from the tightening of financial conditions associated with capital outflows from emerging markets and deteriorating global sentiment.
The MPC noted that the depreciation in the rupee has been lower than in many other emerging markets, reflecting the increased reserve buffers accumulated over the last year. The outlook for the external sector remains stable. Recent data confirms the view that the current account deficit should remain bounded through the Covid-19 crisis due to lower oil prices. In addition, projected official and private inflows are expected to keep the external position fully funded.
On the real side, the decline in LSM deepened to 41.9 percent (yoy) in April, when lockdowns were still in place. In May, high-frequency indicators of activity such as cement dispatches, automobile sales, food and textile exports, and POL sales also continued to contract, although mostly at a lower rate than in the previous two months.
On the external front, the current account swung into surplus in May on the back of a reduction in the trade deficit and a pick-up in remittances compared to the previous month. Meanwhile, portfolio outflows slowed considerably compared to the previous two months and FDI has been resilient, nearly doubling to $2.4 billion so far in FY20 compared to the same period last year.
SBP reserves declined to $ 9.96 billion as of 19th June 2020 largely due to debt repayments. However, since then, SBP has received fresh disbursements from multilateral agencies including around $725 million from World Bank and $500 million from ADB, and another $500 million is expected shortly from the Asian Infrastructure Investment Bank (AIIB).
It may be mentioned here that the ongoing economic slowdown has forced the MPC to call three emergent meeting to review the policy rate. During the last three months overall five meetings of the MPC were held, of which two were scheduled and three were emergency meeting.
The MPC had reduced the interest rate by 75 bps to 12.50 percent in a scheduled meeting on March 17. Just after a week on March 24, the MPC called an emergency meeting in the wake of the evolving economic impact of the coronavirus and decided to cut the policy rate by 150 bps to 11 percent.
A third reduction of 200 bps in the key policy rate was announced by the MPC at yet another emergency meeting held on April 16 to support the economy.
The fourth reduction of 100 bps was decided in a scheduled meeting on May 17, 2020. While, fifth rate cut of 100 bps was announced Thursday. Cumulatively, the MPC has cut the policy rate by 625 bps to 7 percent during the last three months to address the risk to economic growth.
Reuters adds: The SBP's monetary policy committee noted that the path to recovery was uncertain, referring to the IMF slashing its global growth outlook to -4.9%, 1.9 percentage points lower than in April.
SBP said its move to slash the rate is based on the repricing of loans worth 3.3 trillion Pakistani rupees ($19.80 billion) being due in early July.
"In this way, the benefits of interest rate reductions would be passed on in a timely manner to households and businesses."
Copyright Business Recorder, 2020
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