The recent 200-basis-point reduction in the State Bank of Pakistan’s (SBP) policy rate has generated mixed reactions, with some business groups calling for a more aggressive cut of 3 to 5 percentage points. With inflation falling to a six-and-a-half-year low of 4.9% last month, expectations were high for a more dovish stance to bridge the gap between inflation and real positive interest rates. However, the SBP’s decision to remain cautious in its approach reflects a complex economic landscape filled with both positive developments and significant risks.
While the fall in inflation and the three-month Kibor to around 12% had led many to anticipate a more accommodative policy, the SBP has maintained a restrictive stance. This decision is driven by the multiple risks that inflation remains vulnerable to, despite a relatively optimistic macroeconomic backdrop. Inflation is still susceptible to various pressures, and a rapid shift towards growth-oriented policies without adequate structural reforms could lead to undesirable long-term consequences.
On one hand, there are encouraging signs in the economy. Inflation is at its lowest in years, and the current account has posted a surplus for three consecutive months, driven by higher remittances and improved export earnings. As a result, Pakistan’s official reserves have risen to $12 billion in five months, providing some cushion against external shocks. Furthermore, global commodity prices remain subdued, alleviating pressures on both inflation and the import bill, while industrial activity shows signs of recovery.
However, these positive developments do not overshadow the risks that could destabilize the economy if monetary policy is loosened too quickly. The SBP’s recent monetary policy statement highlighted that inflation could remain volatile in the near term due to several key factors. One major concern is the government’s need to raise additional revenue through inflationary taxation measures to bridge a Rs356 billion shortfall in FBR revenues. This could exacerbate inflationary pressures in the economy.
Additionally, while food inflation has eased recently, there is a real risk of resurgence, especially with global commodity prices unpredictable. Moreover, the base effect from last year, which has contributed to the sharp decline in Consumer Price Index (CPI) inflation, is expected to taper off, leading to a potential uptick in inflation. The SBP has also refrained from addressing the delayed increase in energy prices, a factor that has contributed to the current low CPI reading. If implemented, these price hikes would likely contribute to inflationary pressures.
Given these risks, the SBP’s cautious approach is understandable. A hasty attempt to stimulate growth through further rate cuts without addressing structural reforms could push the economy into a much deeper crisis. Rapid monetary easing in an environment where inflation remains volatile could destabilize the economy, undermining the progress made in controlling inflation and building foreign exchange reserves.
The SBP’s stance reflects a measured approach to navigating these complex economic risks. While growth is essential, it cannot come at the cost of long-term stability. Structural reforms, alongside a cautious monetary policy, are necessary to ensure that Pakistan’s economy remains on a sustainable growth path without falling prey to inflationary volatility. The challenge lies in balancing the need for growth with the imperative of ensuring macroeconomic stability.
