LAHORE (Sarfraz Ali) – The State Bank of Pakistan has cut its benchmark interest rate to 7 per cent, which is the lowest in 42 years. Earlier In March, in line with analysts’ expectations, the SBP had reduced the discount rate by 0.5% to 8%. The central bank has cut the key interest rate in the economy by a cumulative 2% since last November partly because of a sharp decline in inflation. As is well known, central banks use the monetary policy tool to control money supply in the economy in order to achieve price stability and economic growth targets.
Explaining its monetary policy decision, the State Bank has stated that macroeconomic conditions towards the end of FY15 have further improved as compared to the beginning of the fiscal year.
Inflation has decreased each month this year as transport and food prices fell. Inflation will average about 4.2% in 2015 before accelerating to 5.4% in 2016. Current account deficit has narrowed down; there is an uptick in real GDP growth; and foreign exchange reserve buildup continues.
All these developments were reflected in the recent upgrades in outlook by international rating agencies. According to SBP, the current macroeconomic stability achieved through domestic policies and favourable external developments provide an opportunity to focus on reforms that will put the economy on sustainable growth path. With contraction in imports, led by sharp decline in oil prices, and strong growth in remittances, the external current account deficit at $1.4 billion during Jul-Apr FY15 is around half of the deficit recorded in the corresponding period of last year. Overall, this has supported the reserve building efforts with net SBP reserves rising from $9.1 billion as of June 30, 2014 to $12.5 billion as of May 15, 2015.
The interest has been cut because inflation continues with its downward trajectory. The year-on-year CPI inflation has declined to 2.1 percent in April 2015 from 8.2 percent in June 2014. The decline in inflation during the current fiscal year has been broad based as all the headline and underlying measures of inflation have recorded deceleration. Soft international commodity prices, stability in exchange rate, lower government borrowings from SBP, moderate aggregate demand, and SBP’s earlier conservative monetary policy stance have remained the key factors in controlling inflation this year. However, uncertainty about international oil prices and possible adjustment in domestic energy prices are the main risks to the inflation outlook.
After remaining tight during most of the current fiscal year, liquidity conditions on the back of overall improvement in the balance of payments have relatively eased towards the end of FY15. The money market overnight repo rate, on average, remained 49 basis points below the SBP’s policy rate in the post-March 2015 monetary policy decision compared to 33 basis points in the post January 2015 decision.
These developments bode well for the smooth transmission of policy rate changes to other market interest rates in addition to the implementation of the revised interest rate corridor framework. In line with the monetary policy stance, market interest rates have fallen since January 2015. With current trends in key macroeconomic variables, money market liquidity is expected to remain easy in the coming months. The latest interest rate should give a fillip to economic activities all round.
