The State Bank of Pakistan (SBP) made a commendable decision to reduce the policy rate by 150 basis points to 20.5 percent. However, the coherence in the regulator’s strategy is missing. SBP is not setting clear targets and seems uncertain about the future, a trend evident in recent policy reviews.
The main issue is that SBP is navigating a delicate balance. The primary concern is managing the external account. A sharp decline in interest rates could create external imbalances due to potential slippage in the current account. Conversely, maintaining high real rates would increase the fiscal burden through debt servicing. Achieving a balance is crucial, especially as inflation is decreasing at a rapid pace.
External vulnerabilities and ongoing negotiations with the IMF for a new program are preventing SBP from being more bold and aggressive. On a positive note, SBP has managed to keep its forex reserves above $9 billion despite repaying around $10 billion of external debt, in addition to around $12 billion of rollovers. However, these rollovers keep SBP in a continuous cycle, much like a hamster wheel.
Another positive development is SBP’s effort to clear the backlog of dividends and profit repatriation. According to the Governor, repayments in May and June alone amount to over $1 billion. Similar feedback is coming from banks’ treasuries. The Governor is confident that all backlogs will be cleared, allowing the next fiscal year to start fresh.
However, the pressure of repayments will persist into the next year along with rollovers. Therefore, SBP cannot afford to run a significant current account deficit. Maintaining a marginal surplus is the only viable option, limiting the scope for reviving economic growth and monetary easing.
SBP is also closely watching the upcoming federal budget, expecting an incrementalist policy approach to continue. “Considering there has been limited progress in addressing structural weaknesses to broaden the tax base and initiate energy sector reforms, FY25 budgetary measures are also expected to be largely rate-based,” stated the monetary policy report.
The absence of reforms and higher rates on existing taxpayers will likely bring some inflation. Rumors suggest that the petroleum levy will increase by 50 percent to Rs90/liter, and partial GST exemptions might be withdrawn. Additionally, electricity and gas prices are expected to rise, adding upward pressure on inflation. SBP expects inflation to remain low even with these adjustments.
However, SBP has refrained from giving next year’s forecast, which the IMF and most analysts expect to remain in the 12-15 percent range. SBP is likely waiting for the budget and the IMF’s final conditions before making its forecast, traditionally announced in July’s review.
Interestingly, SBP has not reiterated its medium-term inflation target of 5-7 percent, which it previously expected to achieve by September 2025. With inflation projected to reach single digits by 2025, SBP’s silence on this target implies either a lack of clarity in its direction or a wait for the IMF program to be finalized.
