The interest rate cut of 200 basis points by the State Bank of Pakistan’s Monetary Policy Committee on Thursday brought the rate down to 17.5 percent from 19.5 percent, as expected. The expectations of a cut were universal, though there was some debate on how much it was going to be. The news of inflation falling from a high of 37.97 percent last May, to 9.60 percent in August meant that the cuts had to continue. After all, the real return was 10 percent before the rate cut, which was far too high. It is no wonder that some industrialists were calling for a 500 basis points cut. However, that much of a cut could have refueled inflation and the MPC did not take the route.
However, inflation, which in guat declined below two digits for the first time in well over a year, is slated to fall further. Though it might not do so at the next ‘fix’, or even the next one, the MPC might have to dial back the interest rate a cumulative 500 bps, to 12.5 percent, which would give the real rate of return of 3.5 percent. However, if inflation declines to about the five to seven percent target (as seems likely by about October), then the rate of return would be the seven percent recommended by some. There are two immediate results of the rate cut. First, the domestic debt servicing burden on the government is reduced. Second, there will be more borrowing by the private sector. Indeed, that is why industrialists are calling for deeper cuts. However, one of the reasons given by the MPC for the rate cut seems a little circular: the last T-bill action showed the MPC was expected to make the cuts. Another factor, one not mentioned, is that inflation is going down globally, so the national rate is going down, so the chances of importing inflation are decreasing.
True, the IMF has recommended keeping rates up, but now that inflation is going down, that advice is becoming outdated. However, it would be foolhardy to expect the MPC to bring down interest rates any faster than it is doing. Not just its decision on Thursday, but its previous decision indicate that it will be cautious in its approach, which is probably the right way of keeping the inflation genie within the bottle.
