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SBP cuts policy rate to 7%, to bolster Pakistan growth

The State Bank of Pakistan (SBP) Monetary Policy Committee (MPC) on Thursday, decided to reduce the policy rate by 100 basis points to 7 percent, amid improvement in inflation outlook.

Meanwhile, 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 shifted toward supporting growth and employment during these challenging times, said SBP in a statement.

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.

The MPC noted that with approximately Rs3.3 trillion worth of loans due to be repriced 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,” it said.

The MPC was of the view that 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 below.

SBP said that the recent SPI data also suggests continued moderation in overall price pressures in June, despite price increases in some food items, notably wheat. 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.

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.

Looking ahead, 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 pandemic both in Pakistan and abroad, maintained SBP.

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.

The SBP said that the cumulative reduction in the policy rate since mid-March to 625 basis points, commensurate with the decline in inflation during this period. The MPC noted 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.

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