The central bank is expected to make a modest interest rate cut

KARACHI:

Pakistan’s central bank is scheduled to meet on Monday (10 June) to review the economic scenario and set the key interest rate for the next six weeks.

Financial markets and experts expect the bank to cut interest rates to a range of 100-200 basis points (bps) in the wake of inflation slowing much deeper than market expectations to a two-and-a-half-year low of 11.8% in May 2024.

The latest monthly inflation has turned the real interest rate positive to 10.2%, which is the difference between the prevailing rate of 22% and inflation of 11.8%.

Speaking to The Express Tribune, Ismail Iqbal Securities Head of Research Saad Hanif noted that the central bank is running the historically high real rate against an average of 2-3% in the past, providing ample scope to cut the policy rate to 400 bps.

However, Hanif suggested the bank would only make a token cut of 100 bps to 21% on Monday, ahead of the presentation of the federal budget. Later, the government is expected to secure a new International Monetary Fund (IMF) loan program.

In addition, the government is expected to impose new taxes and increase tax rates in the budget, which will keep inflation high in the first months of the next financial year.

Meanwhile, the IMF recommended that the central bank maintain a tight monetary policy.

The historically high policy rate of 22% helped the government manage its low foreign exchange reserves of $9.11 billion, mitigating default risk and keeping the rupee stronger against the US dollar. Hanif said a more substantial cut in the policy rate would boost demand for the dollar and cause the rupee to depreciate, although it would support economic activity and job creation.

He argued that the bank had plenty of room to cut interest rates. Despite the inflationary implications of the upcoming budget, inflation will not soar beyond 7-18% in the coming months and will not top 20% next fiscal year.

The bank could potentially cut interest rates by more than 100 basis points if necessary, while continuing to manage demand for the dollar through current policy. This suggests that imports will not exceed the sum of export earnings and workers’ remittances.

In addition, the government will take steps to increase export earnings and promote import substitution, as well as undertake structural reforms to fix the economy. In its previous monetary policy, the State Bank of Pakistan (SBP) highlighted that global central banks such as the US Federal Reserve (Fed) had kept interest rates on hold and delayed the first cut for some time.

However, two global banks, including Canada’s central bank and the European Central Bank (ECB) cut interest rates by 25 basis points this week, bringing rates down from historic highs.

On the other hand, short-term inflation, measured through the SPI, has been on the rise for the past two weeks, mainly due to the reversal in food prices ahead of Eidul Azha.

Rising inflation provides strong ground for the central bank to avoid a rate cut, a scenario that a minority of analysts and investors have not ruled out.

Alternatively, the bank may opt for a symbolic rate cut and continue to maintain a tight monetary policy as recommended by the IMF.

Published in The Express Tribune, June 9^u2024.

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