May 18, 2020 (MLN): Monetary policy committee of the State bank of Pakistan (SBP) at its recent meeting held on Friday i.e. May 15, 2020 slashed the policy rate by a further 100 bps to 8 percent. This rate cut is in addition to the recent reduction in policy rate by 425 bps, taking the cumulative reduction to 525 bps during the last two months since March 17th,2020, the highest cut among emerging countries.
This decision exhibits that the MPC’s view regarding the outlook of headline inflation since its last meeting has further turned encouraging due to the recent 30-40% cut in domestic fuel prices. Consequently, the SBP expecting inflation numbers to be close to the lower end of the previously announced ranges of 11-12% for FY20 and 7-9% for FY21.
The MPC in its statement highlighted that Covid-19 pandemic has created a unique challenge for the monetary policy due to its non-economic origin and the temporary disruption of economic activity required to combat it.
While monetary easing can neither reduce the rate of infections nor it prevents fall in economic activity due to lockdowns. However, SBP through its measures can provide liquidity support to households and businesses to help them through the ensuing temporary phase of economic disruption.
In this context, a combination of reduction in policy rates to ensure maximum liquidity and providing cheap loans has eased the pain for businesses and contained the adverse effects of the outbreak on the economy.
SBP highlighted that this rate cut has been complemented by other measures recently taken by SBP to support the economy, including concessional financing to companies that do not lay off workers , one-year extension in principal payments, doubling of the period for rescheduling of loans from 90 to 180 days and concessional financing for hospitals and medical centers to combat pandemic.
The MPC was of the view that this action together with the government’s proactive fiscal stimulus including targeted support packages for low-income households, SMEs, and construction as well as assistance from the international community, would cushion the impact of the Coronavirus shocks on growth and employment that includes by easing borrowing costs and the debt service burden of households and firms, while also maintaining financial stability. It would also ensure the recovery when the pandemic subsides.
To reach the decision, three key developments were noted by SBP since the last MPC meeting on 16th April 2020. First, the government has reduced petroleum prices by 30-40% due to fall in global oil prices, this improved the outlook for inflation.
Second, most countries, including Pakistan, are easing lockdowns, which will provide support to economy. However, the situation remains highly uncertain as the upsurge in cases could prompt fresh lockdowns, slowing the economic recovery.
Third, due to timely policy actions and international assistance, the initial volatility observed in domestic financial and foreign exchange markets has somewhat subsided in recent weeks. In addition, recent financial support has helped bolster FX reserves of the SBP to over USD 12bn i.e. levels observed prior to outbreak of COVID-19.
MPS also noted that economic data has been consistent with the expected sudden and sharp drop in activity as Large Scale Manufacturing Indicator (LSMI) witnessed a steep decline of 23% YoY in March, due to the withdrawal from economic and social activity aimed at slowing the spread of the virus.
Moreover, high-frequency indicators of demand such as credit card spending, cement dispatches, credit off-take and POL sales also suggest a marked contraction in domestic economic activity in both March and April. At the same time, after showing signs of recovery earlier in the year, both consumer and business sentiment have fallen sharply.
Thus, the receding inflation, contracting economy, and the encouragement from the international agencies including IMF, to ramp-up monetary and fiscal stimulus in the present environment has emboldened SBP to further monetary easing.
The SBP underlined that the inflation outlook is subject to two-sided risks. The inflation could fall further than expected if economic activity fails to pick up as expected in next fiscal year, while potential food price shocks correlated with adverse agricultural conditions pose some upside risks.
Nevertheless, SBP governor believes that inflation is not a concern and focus of the Central Bank remains more on financial stability as he indicated this in his policy statement by stating that future monetary policies will continue to be driven by the pandemic situation in Pakistan; where a worse-than-expected transmission rate and increased lockdown conditions would likely lead to further cuts in the policy rate.
Besides, the SBP governor also highlighted that Pakistan remains in talks with the IMF over the EFF program, and one can expect a staff level agreement soon.
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