During its meeting today, the Monetary Policy Committee (MPC) has opted to keep the policy rate unchanged at 22 percent. The recent inflation data has influenced this decision, indicating a consistent decrease in inflation since it peaked at 38 percent in May, reaching 27.4 percent in August 2023. Despite the recent increase in global oil prices, which has been reflected in consumer costs through adjustments in regulated energy prices, it is anticipated that inflation will continue its downward trend, particularly in the latter part of this year. Consequently, real interest rates may remain positive when viewed from a forward-looking perspective. Furthermore, the projected alleviation of supply constraints due to improved agricultural production and recent regulatory actions targeting speculative activity in the foreign exchange and commodity markets are expected to provide additional support to the inflation outlook.
Monetary Policy Committee Highlights Key Developments
The MPC has taken note of four significant developments since its July meeting. Firstly, there has been a positive shift in the agricultural outlook, with improvements evident in recent data on cotton arrivals, improved input conditions, and satellite data indicating healthy vegetation for various other crops. Secondly, global oil prices have been steadily increasing and have now reached levels above $90 per barrel. Thirdly, as expected, the current account, which had been in surplus for the past four months, recorded a deficit in July. This shift is partly due to the impact of the recent relaxation in import restrictions. Lastly, the recent implementation of administrative and regulatory measures aimed at enhancing the availability of essential food commodities and curbing illicit activities in the foreign exchange market has started to yield results. This has contributed to a reduction in the gap between interbank and open market exchange rates.
The MPC emphasized its commitment to monitoring the potential risks to the inflation outlook and affirmed its willingness to take necessary measures to attain the goal of price stability when deemed necessary. Simultaneously, the MPC underlined the importance of maintaining a cautious fiscal stance to restrain overall demand. This approach is vital to effectively reduce inflation in a sustainable manner and reach the medium-term target of 5 – 7 percent by the end of fiscal year 2025.
Real sector
The latest available high-frequency indicators depict some improvement in economic activity. There is a moderate pick-up in sales of key inputs, like POL, fertilizer, and cement, along with a slight increase in import volumes. At the same time, with better input conditions and the latest updates, the MPC noted that the outlook of the agriculture sector has improved. Earlier concerns related to floods have subsided and cotton arrivals almost doubled from last year. Moreover, the Committee assessed that domestic demand will also remain contained due to the unfolding impact of monetary tightening and envisaged fiscal consolidation. These developments are broadly in line with the MPC’s earlier expectations about moderate growth this year.
External sector
The current account balance recorded a deficit of $809 million in July 2023 after posting surpluses in the preceding four months. This was largely in line with the earlier full-year current account projection for FY24, which already took into account the withdrawal of import prioritization guidelines and the resultant pickup in import volumes. However, the MPC believes that overall imports will remain in check, supported by the favorable trend in non-oil commodity prices, moderate domestic demand, and improved cotton production. Favorable rice prices and available surplus bode well for the export outlook. Moreover, the recent structural reforms related to exchange companies will strengthen their governance structure and improve market functioning. On balance, the Committee expects the current account deficit to remain in the earlier projected range for FY24.
Fiscal sector
In the initial two months of FY24, FBR’s revenues recorded a 27.2 percent increase over the same period last year. This improvement reflects the impact of both fiscal measures and some recovery in economic activity. The MPC views that achieving the targeted primary surplus of 0.4 percent of GDP is critical to support monetary policy in delivering on its objective of price stability. More importantly, attaining fiscal consolidation through broadening the tax base, providing targeted subsidies only to the most vulnerable, and reducing losses of public sector enterprises through privatization or reforms would help bring inflation down in the targeted range and achieve sustainable economic growth over the medium term.
Money and credit
Latest data as of September 1 shows that broad money (M2) growth has decelerated to 13.6 percent on a y/y basis from 14.2 percent observed at the end of June 2023, primarily driven by a significant slowdown in credit to the private sector. Similar to M2, growth in reserve money has also decelerated in FY24 so far. This trend mainly reflects the significant reduction in currency in circulation. Going forward, expected fiscal consolidation, the realization of planned external inflows, and an uptick in economic activity would provide space for a moderate expansion in private sector credit this year.
Inflation outlook
National CPI inflation decelerated to 27.4 percent in August on a y/y basis from 28.3 percent in July, with moderation in food inflation. However, the decline in inflation was lower than anticipated largely due to the surge in global oil prices and their pass-through to administered energy prices. Also, as per the latest surveys, near-term inflation expectations of both consumers and businesses have reversed from their earlier declining trend. The Committee noted that these results partly reflect the impact of heightened uncertainty in the FX markets – particularly in the open market – at the time these surveys were conducted. In this context, the MPC noted the recent regulatory and law-enforcement measures will help address supply constraints in commodity and illegal activity in FX markets.
Brief Inflation Surge in September
These developments – along with an improved agriculture outlook and tight monetary policy stance – will help ensure that inflation remains on the downward trajectory, especially from the second half of this year. The MPC also noted that inflation is likely to increase significantly in September mainly due to the base effect and the adjustment in energy prices. It is expected that inflation will subsequently decline in October and maintain its downward trajectory from thereon.
