KARACHI: A steep fall in main inflation, including core inflation, lower global oil prices and a higher probability of downside risks in comparison to the upside risks led the State Bank of Pakistan to slash the policy interest rate by 50 basis points to six per cent on Saturday.

The bank, announcing the bi-monthly monetary policy, set the target rate as 6pc and ceiling rate of the interest rate corridor as 6.5pc for the next two months.

The last cut in the policy rate was made in May by 100 basis points while in July the bank expressed some fear about the possible rise in the inflation and kept the rate unchanged.

“Recent increases in natural and compressed natural gas prices and their likely second round impacts would be offset by lower global oil price that has yet to find the bottom,” said the State Bank.

There was no change in SBP’s forecast of average CPI inflation for FY16 with its range of 4.5-5.5pc, remaining below the annual plan target of 6pc.

“With current trends and projections, the probability of downside risks appear to be greater than the upside risks,” said the SBP.

There are two possible upside risks to this forecast. One, the government plans of paring down of subsidy on electricity along with an increase in its tariffs and two, the possible adverse impact of low food prices on crop production.

Downside risks to the forecast include the lesser likelihood of recovery in prices of global commodities, including oil.

Since the interest rate policy has a direct link with inflation, the State Bank took a detailed analysis of impacts over possible variations in inflation during the year.

Year-on-year headline CPI inflation decelerated to 1.7pc in August from 7pc in the same month last year. Following its declining trend of the past several months, the 12-month moving average CPI inflation came down to 3.6pc last month from 8.4pc in the same month last year.

Other indicators, such as core inflation measures, have also decreased in August.

“The current deceleration owes much to the smooth supply of the perishable food items and falling international oil price pass-through to consumer prices,” said the State Bank.

The situation in external current account at the beginning of FY16 is not much different from the end of the last financial year. While the exports again declined in July 2015, external current account deficit recorded slight improvement due to declining oil import payments and increasing workers’ remittances.

“With favourable trends in these variables, a current account deficit of the size of end-FY15 seems manageable in this fiscal year.”

This is supported by the expected surplus in the capital and financial account in FY16 on the back of planned Euro/Sukuk bonds inflows, official disbursements, and the remaining IMF funding, the bank added.

However, increases in exports and foreign direct investments are imperative for sustainability of external sector.

“In this regard, recent improvements in the law and order situation and continued macroeconomic stability are likely to increase the prospects for long-term foreign capital inflows,” it said.

With better law and order situation, investor and consumer confidence is improving, it added. After recording a growth of 3.3pc, large-scale manufacturing is expected to gain further traction at the back of improvement in energy supplies.

“Implementation of infrastructure development and energy projects under China-Pakistan Economic Corridor would further enhance the improving investment environment,” it said.

“There is anticipation of higher economic activity in FY16 which is expected to boost credit uptake.”

The central bank cut the interest rate by 350 basis points since November last year, but the private sector did not show interest to borrow from banks. In fact, the borrowing fell compared to the last year when the interest rate was in double digits.

The sole beneficiary of the low interest rate is the government because it has to pay less with low interest rate.

The State Bank said that much needed boost to Pakistani exports may come through US economic recovery and through further gains in EU’s GSP-Plus scheme.

“However, structural bottlenecks especially in the textile sector and subdued international commodity prices remain the major risk to exports outlook.”

It said the monetary conditions, despite easing, still appear to be tight as real lending rates are hovering around 4pc since December FY14 due to rapidly falling inflation.

Published in Dawn, September 13th, 2015

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