ISLAMABAD: In its recent meeting, the Monetary Policy Committee (MPC) decided to maintain the policy rate at 22 percent. The committee acknowledged that headline inflation had risen in September 2023 as anticipated but expected a decline in October and a sustained downward trajectory, particularly in the latter half of the fiscal year.
However, the MPC recognized some potential risks to the inflation and current account outlook, including recent volatility in global oil prices and the upcoming increase in gas tariffs in November 2023. They also highlighted mitigating factors, such as targeted fiscal consolidation in the first quarter, improved availability of key commodities in the market, and alignment of interbank and open market exchange rates.
The MPC took note of several significant developments since their September meeting. Encouraging initial estimates for Kharif crops are expected to have positive effects on various sectors of the economy. The current account deficit notably reduced in August and September, stabilizing the State Bank of Pakistan’s foreign exchange reserves despite limited external financing during these two months. Fiscal consolidation progress remained on track, with both fiscal and primary balances improving in the first quarter of FY24. While core inflation remained sticky, there were improvements in inflation expectations among consumers and businesses from the latest pulse surveys. The MPC recognized the ongoing volatility in global oil prices and the heightened uncertainty due to conflicts in the Middle East.
Considering these developments, the MPC emphasized the importance of maintaining a tight monetary policy stance. They reiterated their view that the real policy rate, looking forward 12 months, remains significantly positive and is appropriate to achieve the medium-term inflation target of 5 – 7 percent by the end of FY25. However, the committee stressed that this outlook relies on the continuation of fiscal consolidation and the timely realization of planned external inflows.
In the real sector, recent economic data reinforced the MPC’s earlier expectations of moderate growth for the current year. Notably, the latest production estimates for major Kharif crops showed a considerable increase compared to the previous year. This improvement was supported by higher fertilizer uptake and improved water availability. Other key activity indicators, such as cement, petroleum, oil, and lubricants (POL) sales, as well as auto sales, were showing moderate recovery. Additionally, large-scale manufacturing (LSM) output indicated gradual improvement in the first two months of the year, with a major contribution from domestic-oriented sectors.
In the external sector, the MPC observed a substantial improvement in the current account balance, with a significant year-on-year reduction of over 58 percent to $947 million in July-September FY24, almost leveling out in September 2023. Exports and workers’ remittances improved in September compared to the previous two months. Reforms related to exchange companies, introduced in early September, along with administrative actions against illicit market activities, helped enhance foreign exchange market sentiment and liquidity. Improved inflows in the interbank market stabilized the State Bank of Pakistan’s foreign exchange reserves at around $7.5 billion as of October 20, despite limited official inflows in August and September. Nevertheless, the MPC highlighted the importance of a successful and timely completion of the upcoming IMF-SBA review to unlock additional multilateral and bilateral financing.
In the fiscal sector, Q1-FY24 witnessed improved fiscal indicators compared to the same period in the previous fiscal year. Specifically, the fiscal deficit improved to 0.9 percent of GDP from 1.0 percent, and the primary balance posted a surplus of 0.4 percent, compared to 0.2 percent the previous year. This improvement was attributed to better revenue collection and controlled spending. The Federal Board of Revenue’s (FBR) revenue recorded a significant growth of 24.9 percent over the same period the previous year. Similarly, non-tax revenues almost doubled, primarily due to a sharp rate-driven increase in Public Debt Limited (PDL) collection. Total expenditures remained at last year’s level, supported by a substantial reduction in subsidies and grants. The MPC emphasized the importance of continued fiscal prudence and meeting targeted fiscal consolidation to keep inflation on a downward trajectory.
Regarding money and credit, the growth of broad money (M2) decelerated to 12.9 percent as of end-September from 14.2 percent at end-June 2023, primarily due to a continued slowdown in private sector credit and more than seasonal retirement in commodity operations financing. Similarly, the growth of reserve money slowed down from June, mainly explained by a significant deceleration in the growth of currency in circulation. The MPC noted that since June, the Net Foreign Assets (NFA) of the State Bank of Pakistan (SBP) and the banking system expanded, primarily due to significant foreign exchange inflows in July, while Net Domestic Assets (NDA) contracted, resulting in an improved composition of both M2 and reserve money. It is also expected that planned fiscal consolidation and the realization of anticipated external inflows will create room for increased credit to the private sector and enhance the NFA of the banking system.
In terms of the inflation outlook, headline inflation surged to 31.4 percent year-on-year in September, as anticipated. The MPC expects a significant decline in inflation in October due to downward adjustments in fuel prices, easing prices of some major food commodities, and a favorable base effect. The committee reaffirmed its earlier assessment that inflation will decrease substantially in the second half of FY24, barring any major adverse developments. The recent uptick and volatile trend in global oil prices, as well as the second-round effects of a substantial increase in gas tariffs, pose some upside risk to the inflation outlook. Core inflation has also remained at elevated levels, hovering around 21 percent over the last four months. However, the committee noted that fiscal policy measures, coupled with improved availability of food commodities, are likely to complement the central bank’s efforts to bring down inflation.
