ISLAMABAD: The Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) announced a 100 basis points (bps) cut in the policy rate, bringing it down to 12%, effective January 28, 2025. The decision reflects the continued downward trend in inflation, which reached 4.1% year-on-year in December, in line with expectations. This decline is attributed to moderate domestic demand, supportive supply-side dynamics, and a favorable base effect. The MPC expects inflation to decrease further in January before experiencing a slight uptick in the following months. While core inflation is easing, it remains elevated. Meanwhile, economic activity continues to improve gradually, with the impact of a cumulative 1,000 bps policy rate reduction since June 2024 still unfolding.
Key Economic Developments
The MPC highlighted several critical economic developments since its last meeting:
- GDP Growth: Real GDP growth in Q1-FY25 was slightly below the MPC’s earlier projections.
- Current Account Balance: The current account remained in surplus in December 2024; however, SBP’s foreign exchange reserves declined due to low financial inflows and high debt repayments.
- Tax Revenue: Despite a notable increase in December, tax revenues for H1-FY25 remained below target.
- Global Oil Prices: Recent weeks have seen heightened volatility in global oil prices.
- Global Economic Policy Environment: Rising uncertainty has prompted central banks worldwide to adopt a cautious approach.
Considering these developments, the MPC stressed the need for a cautious monetary policy stance to maintain price stability, which is essential for sustainable economic growth. The Committee emphasized that the real policy rate must remain sufficiently positive on a forward-looking basis to stabilize inflation within the target range of 5-7%.
Real Sector Performance
Recent high-frequency indicators suggest continued momentum in economic activity. Notable increases were observed in automobile, petroleum, and fertilizer sales, as well as in import volumes, electricity generation, and private-sector credit disbursement. However, provisional Q1-FY25 GDP data showed a modest growth of 0.9%, compared to 2.3% in Q1-FY24. This slowdown was mainly due to a sharp deceleration in agriculture sector growth, which dropped to 1.2% from 8.1% in the previous year. Additionally, satellite imagery suggests a relatively modest wheat crop output. Meanwhile, the decline in industrial sector growth moderated compared to last year. Key industrial sectors such as textiles, food and beverages, and automobiles have shown improvement, while business confidence indicators remain positive. The MPC expects economic activity to gain further traction, with GDP growth projected in the range of 2.5-3.5% for FY25.
External Sector Outlook
Strong workers’ remittances and export earnings contributed to a $0.6 billion current account surplus in December, bringing the cumulative surplus for H1-FY25 to $1.2 billion. Exports, led by high-value-added textiles, maintained strong momentum, while import growth accelerated due to higher volumes, indicating improved economic activity. While the import bill outpaced export earnings, remittances offset the widening trade deficit. Given these trends, the current account balance is now expected to remain between a surplus and a deficit of 0.5% of GDP in FY25. Net financial inflows, which remained subdued in H1-FY25, are anticipated to improve as a significant portion of official debt repayments has already been made. Consequently, SBP’s foreign exchange reserves are expected to exceed $13 billion by June 2025.
Fiscal Sector Performance
FBR tax revenues grew by approximately 26% in H1-FY25. However, the shortfall in tax collection widened, necessitating a sharp acceleration in revenue growth to meet the annual target. Meanwhile, estimates from the financing side suggest an improved fiscal balance, with relatively contained expenditures. The MPC noted that lower-than-expected interest payments could help contain the overall fiscal deficit. However, achieving the primary balance target remains a challenge.
Money and Credit Trends
Broad money (M2) growth decelerated further to 11.3% year-on-year as of January 17, compared to 13.3% at the time of the previous MPC meeting. This slowdown was mainly due to a significant deceleration in Net Domestic Assets (NDA) growth. Government borrowing from the banking system remained controlled and shifted towards non-bank sources, while private-sector credit growth accelerated, driven by economic recovery, easing financial conditions, and banks’ efforts to meet Advances-to-Deposit Ratio (ADR) thresholds. As a result, bank deposits declined noticeably, while currency in circulation increased.
Inflation Trends and Outlook
Headline inflation continued its downward trajectory, easing to 4.1% in December from 4.9% in November. The decline was primarily driven by lower electricity tariffs, an adequate supply of essential food items, exchange rate stability, and a favorable base effect. Core inflation, though moderating, remains elevated, and inflation expectations have been volatile. The MPC reiterated that near-term inflation will fluctuate and may rise towards the upper bound of the 5-7% target range by the end of FY25. Headline inflation for FY25 is projected to average between 5.5-7.5%. The outlook, however, remains subject to risks from global commodity price volatility, protectionist policies in major economies, administered energy tariff adjustments, fluctuations in perishable food prices, and potential fiscal measures to meet revenue targets.
