Central bank slashes policy rates by 100bps to 8.5 percent

KARACHI: The central bank cut its key policy rate for the second time in two months on Saturday, in line with the market’s expectations, amid signs of cooling inflation and contained fiscal deficit.
In a move that had been widely expected, the State bank of Pakistan announced 100 basis point cut in the discount rate to 8.5 percent, aiming at adding momentum to an economic recovery that is proving slow to take off due to looming energy crisis in the country.
But for market surprise Finance Minister Ishaq Dar, over an hour before the central bank’s announcement, disclosed the 100 basis point cut, casting doubts on the independence of the central bank.
Analysts believe the central bank may have come under pressure from the government for a 100 basis points cut in discount rate, otherwise it would ideally choose a gradual easing. The central bank enjoys policy autonomy but lacks the kind of independence enjoyed by central banks in the west, on interest rates.
The central bank slashed key interest rate by half a percentage point to 9.5 percent in November.
Ashraf Mehmood Wathra, the central bank governor said the recent plunge in international oil price had induced low inflation and improved trade outlook, but there were risks to future inflation.
“The speed and intensity, with which the inflation has come down and continues to recede, can induce expectations of rather low inflation, which may induce additional consumption,” Wathra said at a news conference. “The recent reduction in domestic commodity prices may lead to more spending.”
Analysts said over 50 percent fall in global crude prices since July has brought inflation down, lowered the import bill and reduced government spending on food subsidies.
The headline monthly inflation, measured by the consumer price index (CPI), was recorded at 4.3 percent in December 2014 compared to 3.96 percent in the previous month and 9.2 percent in December 2013.
Wathra said the impact of November policy rate cut on the economy is subject to a lag and various other factors continued to pull the headline inflation on annual basis down in December.
“This disinflation is broad based as both food and non-food inflation have been declining. The deceleration in the former is mainly the result of better supply conditions, while the latter is explained by a combination of factors, including plummeting international oil price as well as decline in other global commodity prices; lagged impact of earlier conservative monetary policy stance and moderating aggregate demand; and stable exchange rate,” he added.
REVISED INFLATION TARGET
Wathra said inflation is likely to decrease further going forward after a cut in domestic oil prices and its impact on transport services.
“Accordingly, SBP has revised downwards its forecast range for average CPI inflation to 4.5 – 5.5 percent for FY15, well below the annual target of 8.0 percent,” he added.
The governor said soft international oil price, through its expected favorable impact on trade balance, contributed in improving the external sector outlook in recent months.
A successful completion of fourth and fifth review under IMF’s $6.6 billion bailout package and last year’s issuance of international sukuk have also supported the balance of payment position.
“With IMF program on track and expected proceeds from privatisation and official flows, the net SBP reserves are projected to increase further,” Wathra said.
The governor, however, cautioned that delay in some planned privatisation proceeds and lack of private inflows “could pose risks in achieving a sustainable balance of payment position.”
Wathra stressed for policies and reforms to attract foreign direct investment and to exploit benefits from the recently granted generalised scheme of preferences plus status by the European Union.
REVENUE COLLECTION
The governor said the government borrowing from the SBP remained below the agreed targets in the first quarter of the current fiscal as government managed to contain expenditures related to public sector enterprises and at the same time increased the development spending.
“However, growth in FBR revenue collection moderated due to downward adjustment in petroleum prices and slowdown in large-scale manufacturing (sector),” he added. “Going forward, overall expenditures could increase due to higher security related expenditures. This, along with expected shortfall in FBR revenues, may make meeting the fiscal deficit target more challenging.”
He said expected external inflows are likely to reduce the budgetary borrowing requirements from scheduled banks and would improve liquidity conditions in money market.
“Availability of cheap raw material, low input cost, and healthy construction activity, as indicated by higher cement sale and steel production, are expected to benefit commodity producing sector,” he added.
Wathra said a limited impact of floods on rice and sugarcane crops and incentives for Rabi crops brightened the prospects for a better agriculture sector performance this fiscal year.
“In this backdrop, the real GDP is therefore expected to maintain the growth momentum achieved in the last year into FY15 as well”.