Benefits of lower interest rates and fuel prices.

Byline: Ahsan Nisar

Central banks around the world have slashed interest rates, though perhaps none as aggressively as State Bank of Pakistan (SBP). According to a recent report by Bloomberg, Pakistan has cut its interest rates the most this year, out of a survey of nine countries, including the US, Peru, South Africa, Turkey and Ukraine. Coronavirus has created 'unique' challenges for a monetary policy due to its non-economic origin. In last three months, SBP has slashed the policy rate four times. In the space between March 17 and May 15, the SBP has cut the policy rate by a whopping 525 basis points, from the relatively high 13.25% to 8%.

While SBP acknowledges that easier monetary policy can neither affect the rate of infection transmission nor prevent the near-term fall in economic activity due to lockdowns, it can provide liquidity support to households and businesses to help them through the ensuing temporary phase of economic disruption. The SBP also maintained that the rapid policy rate cuts had helped maintain credit flows and bolstered cash flow of borrowers, thereby limiting contraction in the economy.

Inflation expectations

According to the SBP, inflation could fall closer to the lower end of the previously announced ranges of 11-12 percent this fiscal year and 7-9 percent next fiscal year. In January 2020, the inflation rate had hit a record 14.56%, according to data released by the Pakistan Bureau of Statistics (PBS). However, it has been declining since, slowing to 12.4% in February, and then to 10.24% in March, finally settling at 8.5% in April. Many analysts expect it to drop to 8% or 7% in the coming months.

For its part, SBP said that the significantly reduced petrol and diesel prices by 30-40%, in response to the continued fall in global oil prices, will further reduce inflation. It also said that both the fall in inflation in Pakistan since January and the expected further decline next year are the highest among comparable emerging markets.

However, inflation could fall further than expected if economic activity fails to pick up as expected next fiscal year. On the other hand, there are some upside risks from potential food-price shocks associated with adverse agricultural conditions due to locust attacks. Price pressures could also emerge if the economy gains greater momentum in the second half of FY21.

Outlook for Pakistan

Exports have declined by 10.8% YoY in March, while imports contracted by 19.3% YoY. The figures...