Pakistan cut its benchmark interest rate for the next two months, expecting the low inflationary trend to continue in the 2015-16 fiscal year, and taking into account favorable trends in external accounts.
The central bank cut the key policy rate to a 42-year-low of 6 percent from 6.5 percent, the bank said in a statement on September 12. Pakistan had made no changes in the key interest rate in the previous review in July.
Year-on-year headline inflation decelerated to 1.7 percent in August from 7 percent in the same month last year, bringing down the 12-month moving average consumer price index (CPI) inflation to 3.6 percent in August, 2015, compared with 8.4 percent in the corresponding period of last year.
“Thus, there is no change in SBP’s forecast of average CPI inflation for FY16 with its range of 4.5-5.5 percent remaining below the annual plan target of 6 percent.”
Low inflationary trend in Pakistan has been supported by falling international oil prices that in turn has reduces prices of perishable food items. Lower global oil prices that has yet to find the bottom will also likely offset the recent increase in natural gas prices, according to the report.
There are, however, two possible upside risks to this forecast.
Government plans of paring down of subsidy on electricity along with increase in its tariffs and the possible adverse impact of low food prices on crop production. Downside risks to the forecast include the lesser likelihood of recovery in global commodity prices including that of oil.
The situation in external current account at the beginning of FY16 is not much different from the end of the last fiscal year. While the exports again declined in the month of July 2015, external current account deficit recorded slight improvement due to declining oil import payments and increasing workers’ remittances.
A manageable current account deficit is supported by the expected surplus in the capital and financial accounts in FY16 on the back of planned Euro/ Sukuk bonds inflows and remaining disbursement of IMF funding under the Extended Fund Facility secured in September, 2013. This would also help maintain the foreign exchange reserves’ upward trajectory of the last two fiscal years.
“The decision reflects stability in the economy,” Finance Minister Ishaq Dar said on the bank’s decision to cut rate, adding that efforts were on to achieve $21 billion target for forex reserves within the current calendar year.
The central bank also expressed the hope that economic recovery in the United States will give much needed boost to Pakistani exports, in addition to gains coming from the country’s GSP-Plus status with the European Union.
However, structural bottlenecks especially in the textile sector and subdued international commodity prices remain the major risk to exports outlook.