Maintaining the policy rate
EDITORIAL: The Monetary Policy Committee (MPC) decided to keep the policy rate unchanged at 11 percent in spite of an increase in the Consumer Price Index (CPI) to 3.5 percent year-on-year in May 2025 (from 0.3 percent in April) — the highest since January 2024 when CPI was calculated at 2.4 percent — and more tellingly the Monetary Policy Statement (MPS) projected that 'some near term volatility in inflation is expected before it gradually inches up and stabilises within 5 to 7 percent.'
The average CPI for the year 2024-25 was calculated by the Pakistan Bureau of Statistics (PBS) at 4.61 percent — lower than the projected increase next fiscal year.
Core inflation declined to 7.3 percent last month (May), the lowest since May 2024. But in April 2025 core inflation was 0.1 percent higher than in May — at 7.4 percent — that may have been the basis for the MPS to refer to 'persistence in core inflation' though this so-called persistence was not evident in data from January to March 2025: 7.8 percent in January, 7.8 percent in February and 8.2 percent in March.
The MPS noted that real interest rate remains adequately positive to stabilise inflation; however, if CPI had been used as a yardstick to adjust the discount rate (as it was during 2019 to 2022) then it should have been raised by 25 to 50 basis points and if core inflation was used as a yardstick then it could have been reduced by 25 basis points.
This lends credence to the widely-held belief that the International Monetary Fund (IMF) did not approve any adjustment in the policy rate at this time — a decision that is inexplicable, given that the MPC met on 16 June (Monday) while a hike in domestic prices of oil and products was announced a day earlier (effective Monday) due to the rise in the international oil prices as a consequence of the ongoing Israel-Iran conflict and yet the MPS reads 'energy prices continued to remain lower than last year, mainly reflecting the impact of moderation in global oil prices' — an observation that does not justify the policy rate remaining unchanged from 16 June onwards.
The influence of the IMF on the MPS is evident from its contention that 'economic growth is picking up gradually and is projected to gain further traction next year, supported by the still unfolding impact of earlier policy rate cuts,' which mirrors the IMF statement in the first review documents uploaded a month ago notably, 'the MPC's decision to hold the policy rate in their March 10 meeting was appropriate, allowing time for past rate cuts to feed through to the economy.'
This growth of 2.7 percent in the outgoing year belies two macroeconomic indicators: (i) the negativity suffered by the large-scale manufacturing sector rose from negative 0.22 percent July-March 2023-24 to negative 1.47 percent in the corresponding period 2024-25 as per data uploaded by the Finance Division; and (ii) agriculture crops underperformed; however, PBS upped the livestock growth which faces challenges in terms of collecting accurate data (comprising a little over 14 percent of agriculture's total 24 percent contribution to GDP) and services again not credibly accounted for, given that it constitutes mainly wholesale and retail trade which mainly operates outside the legal economy.
The MPS further notes that growth accelerated to 3.9 percent during the second half of 2024-25 compared to 1.4 percent in the first half, which was as per MPC expectations. However, there is little evidence of this growth spurt in the second half of this year.
Keeping the policy rate unchanged may have repercussions on yet to be approved by parliament budget 2025-26, given that the 738.677 billion-rupee lower mark-up budgeted for next fiscal year from the revised estimates of the outgoing year (in spite of a massive rise in bank borrowing to the tune of 3.438 trillion rupees) may adversely impact the budget balance sheet.
The MPS rightly noted two major positive macroeconomic outcomes: the completion of the first IMF review which led to a disbursement of one billion dollars that strengthened foreign exchange reserves (which remain largely sourced to debt); and primary surplus of 2.2 percent of GDP in the current year (a Fund condition that has led to an increased reliance on incurring debt/debt equity) budgeted at 2.4 percent in 2025-26, which will have to be reassessed if the discount rate is not lowered during the year though here the MPS has noted that this would reflect 'the evolving geopolitical situation in the Middle East and some ease in the US-China trade relations.'
The SBP is tasked by the IMF to achieve what the Fund has noted in the first review: 'changes to central bank communication, particularly greater clarity on the MPC's assessment of the current and desired policy stance, have been welcome and should continue to help the public better understand the MPC's reaction function to incoming data, and guide expectations between meetings'. This can only be described as work in progress at this point in time.
Copyright Business Recorder, 2025
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