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The monetary policy is due on Monday, and it’s hard to make a call, as there are reasons to justify a token cut (50-100 bps) and there are reasons to maintain the policy rate at 22 percent. Inflation on a forward-looking basis is reducing, and the base effect is bringing inflation below 20 percent in March. However, last month’s reading was 29 percent and the latest weekly inflation readings are still too high.

The base effect is simple math where any sudden increase has an impact for 12-Months and thereafter it wanes. In January and February 2023, the PKR was artificially kept in Rs220s against the dollar while the open market was moving up, and there were sudden jumps; the currency stabilized in 280s. The sudden jumps in currency had kept the inflation base effect high; this is going to end in March 2024. Interestingly, the USD is trailing around Rs280 – the levels during the previous March. Then there was the impact of the increase in energy prices – electricity and petroleum – which had also kept inflation high.

Now the PKR is stable and petroleum prices are coming down (due to low international prices). These are factors that are bringing the inflation expectations down and building a case for the easing of the monetary policy. That is why the secondary market yields are significantly down, which implies that the market is expecting a sharp decline in the interest rates going forward.

Having said that, the energy circular debt is not coming down despite successive increase in electricity and gas prices, and there is a case of further increase in prices going forward, which can dilute the expectations of sharp decline in inflation. However, one must also acknowledge that the gas price increase calculations in Nov 23 was too high in the CPI/SPI due to the limitation of the methodology and had an additional impact of 2 percentage point increase in inflation for 12 months (more on this later).

However, there is little or no second-round impact of increase in domestic gas prices. That is not the case for electricity where there are second round impacts, and any further increase could bring inflation up again. The IMF commentary in its recently released report doesn’t really support a rate cut at this moment.

The risk of an expected increase in energy prices is compensated by prudent fiscal policy, as there was a primary surplus in the first quarter and last rounds of increase in energy prices are lowering the burden of these on the fiscal side. This will bring the government credit demand low whereas the private credit growth is already negative in real terms.

The key is to look at the month-on-month inflation – it was low in December, as in winters the food (especially) perishable inflation is low. If the MoM inflation remains below 1-1.25 percent, there is a strong case for a sharp cut going forward.

The other important factor is demand and its impact on inflation and external accounts. The demand has been substantially suppressed, and it’s showing on sharp decline in imports. The SBP is no longer “managing” as the toll is down anyways. The current account is in control and there is no panic inholding PKR (as was the case 6-12 months ago). These factors build a case for rate cut.

The question is what to do on Monday – should SBP go for a token cut or maintain the status quo? There are reasons to support both. Let’s dissect the impact of a rate cut – it’s going to lower the fiscal cost (by lowering rate of T-Bills) and private borrowers cost (by lowering the KIBOR), and lower the return of banks’ saving depositors. In the cases of fiscal and private borrowers, the cost is already low as both T-Bill and Kibor are 2-2.5 percent lower than the discount rate, and the policy rate becomes irrelevant. However, in case of a rate cut, depositors will take a hit. Hence, it’s better to keep the rate unchanged, so savers can have higher incentives for keeping savings in PKR.

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