Bold on policy cut, timid on targets

The SBP took the correct decision to reduce the policy rate by 150 bps to 20.5 percent. However, the coherence in the regulator’s behavior is missing. SBP is not setting any target and seems unconvinced moving forward. This incoherent behavior is visible from the past few policy reviews.

The issue is that SBP is walking on a tightrope. The main concern is how to manage the external account. If the interest rates decline sharply, it can create external imbalances due to possible slippage in the current account. And if the real rates are kept too high, there would be an additional burden on the fiscal side through debt servicing. The key is to keep this balance, as inflation is clearly coming down at a faster pace.

The external vulnerabilities and ongoing negotiation with the IMF on the likely new program are not letting SBP be bold and aggressive.

The good news is that SBP has managed to keep its forex reserves at over $9 billion despite repaying around $10 billion of external debt. This is in addition to around $12 billion of rollovers. The issue is that the roll-overs are keeping SBP on a roll, as they keep on rolling - synonymous with a hamster wheel.

The other good news is that SBP is pushing hard to clear the backlog of dividends and profit repatriation. According to the Governor, the repayments in May and June alone are over $1 billion. Similar feedback is coming from banks’ treasuries. The Governor is confident that all the backlogs will be cleared up and next year will start fresh.

However, the pressure of repayment would not go anywhere in the next year along with rollovers. Thus, SBP simply cannot afford to run a healthy current account deficit. And running a marginal surplus is the only option. That is enough for SBP to not think about reviving economic growth, and that will limit the monetary easing.

The other variable SBP is keenly looking for is the upcoming federal budget where SBP expects incrementalist policy will continue. “Considering there has been limited progress in addressing the structural weaknesses to broaden the tax base and initiate energy sector reforms, FY25 budgetary measures are also expected to be largely rate-based.”, the monetary policy stated.

The absence of reforms and higher rates on existing taxpayers will bring some inflation. The grapevine is that the petroleum levy will be increased by 50 percent to Rs90/liter and partial GST exemptions will likely be withdrawn. The energy- electricity, and gas, prices will most probably be revised upwards. All this would put upward pressure on inflation. And SBP expects inflation to remain low even after incorporating all of these.

However, SBP has shied from giving next year’s forecast which IMF and most analysts expect to remain in the band of 12-15 percent. SBP is perhaps waiting for the budget and the IMF final conditions before making its forecast, and traditionally, SBP announces its forecast in July’s review.

Another interesting nugget is that SBP has not given its medium-term inflation target of 5-7 percent whereas in the past three policy reviews, SBP was expecting this to be achieved by September 2025. And now when inflation is looking to come to single digits in 2025, SBP is refraining from stating that. This implies that either SBP lacks clarity in the direction or is waiting for the IMF to finalize the program.