Third cut since March 17
The State Bank of Pakistan, in an emergency meeting on Thursday, slashed the monetary policy rate by 200 basis points to 9%. This move, the third cut since March 17 when the rate was 13.25%, is aimed at stimulating economic activity after global financial institutions warned the world is heading towards a recession feared to be deeper than the 2009 financial crisis.
“The world economy is expected to enter the sharpest downturn since the Great Depression, contracting by as much as 3% in 2020, according to projections released this week by the IMF. This is a much deeper recession than the 0.07% contraction during the global financial crisis in 2009,” the SBP said in a statement.
Pakistan’s economy is expected to contract by 1.5% in the fiscal year ending June 30, 2020, the bank added. “Domestically, high-frequency indicators of activity―including retail sales, credit card spending, cement production, export orders, tax collections, and mobility data from Google’s recently introduced Community Mobility Reports―suggest a significant slowdown in most parts of the economy in recent weeks,” the bank said.
Keeping this changing economic outlook in mind, the central bank decided to cut the interest rate for the third time in a month.
Controlling inflation and ensuring economic stability are two of the SBP’s core functions. To achieve them, the central bank uses, among other tools, its policy rate, the interest rate at which commercial banks borrow money from the central bank.
Revised every two months, the SBP’s policy rate affects every interest rate in the market. A cut in the SBP’s rate means commercial banks will also drop their interest rates, making borrowing cheaper for individuals, businesses and the government that borrows more and spends more, thus boosting economic activity.
On March 17, the central bank cut rates by 75 basis points. As more and more countries went into lockdown to contain the spread of Covid-19, the world economy came to a grinding halt, which changed the growth outlook, forcing the SBP to cut the rate by another 1% on March 24. The latest rate cut comes after the IMF and World Bank warned of a recession.
“This reduces forward-looking real interest rates (defined as the policy rate less expected inflation) to around zero, which is about the middle of the range across most emerging markets.” the SBP said. “The Monetary Policy Committee was of the view that this action would cushion the impact of the coronavirus shock on growth and employment, including by easing borrowing costs and the debt service burden of households and firms, while also maintaining financial stability.”
The SBP says the latest rate cut will help ensure that economic activity is better placed to recover when the pandemic subsides. Reducing interest rates can cause inflationary pressure, but the SBP said there was a marked reduction in inflation momentum in March and also in the weekly sensitive price index in April.
“Inflation is expected to be close to the lower end of the previously announced 11-12% range this fiscal year, and to fall to 7-9% range next fiscal year,” the bank said. While there are some upside risks to headline inflation in case of temporary supply disruptions or food price shocks, these are unlikely to generate strong second-round effects due to the weakness of the economy, it added.
The SBP said, “this rate cut would complement other measures recently taken by the bank 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 incurring expenses to combat the coronavirus pandemic.”