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Since the last monetary decision was made in November of 2014, key macroeconomic indicators have shown improvement. CPI inflation and its expectations have continued to follow a downward trajectory and in the months of November and December 2014, the trade deficit has also declined, however, it did increase in the first half of the fiscal year 2015 in comparison to the same period of FY 2014. Additionally, inflows of foreign exchange have also contributed towards foreign exchange reserves maintaining an upward trajectory. What is encouraging further is that the fiscal deficit has been contained which bodes well for the credibility of the policies of the government as well as for the continuation of private and official capital inflows. With such positive developments, the first half of the present fiscal year has certainly managed to end on a better macroeconomic outlook.
Considering the monetary policy, however, the State Bank of Pakistan brought down the mark up rate to 8.5% from the previous 9.5%. The reduction was in line with what analysts expected and furthermore due to the fall in world oil prices, the inflationary pressure being experienced was low as well. The Governor of the State Bank of Pakistan also stated that the mark up rate would remain the same for the upcoming 2 months after which it would be revised again if necessary.
The move was also approved by the business community as they were already pushing for the monetary policy to be eased in order to encourage investment from the private sector as well as to increase economic growth.
The capital markets had already predicted this downward revision and factored it in much before the announcement was made.
One of the main reasons the interest rate was reduced was due to the low rate of inflation. The central bank also revised the rate of inflation and expect it to fall somewhere between 4.5%-5.5% towards the end of the fiscal year. This was against the annual target of 8%. Apart from the monetary policy being a reason, the fall in inflation is also due to the falling trend of global commodities prices, oil in particular; low food inflation; the phasing out of the electricity price hike which took place in October 2013, low amount of borrowing by the government from the State bank of Pakistan as well as the benign inflationary expectations for the upcoming months of the remaining fiscal year.
Inflation
The declining inflation is attributed to the decline in food and non-food inflation, both. Taking food inflation, the rate has come down to 5.1% during the first half of the fiscal year 2014-2015. This is in comparison to the 9.9% rate in the corresponding period of the previous fiscal year. Due to better supply conditions, food inflation has been falling while the latter has experienced a decline due to the fall in global oil prices but also due to global commodity prices falling. A stable exchange rate and a moderating aggregate demand have also had a role to play in leasing inflation to decline.
The State Bank of Pakistan (SBP) has further revised the inflation target for the fiscal year 2014-15. It is now projected to be in the range of 4.5 to 5.5 percent against the annual target of 8 percent. The bank attributed low inflation to falling oil prices primarily.
The central bank issued the first quarter (July-September) report on Tuesday, which says the inflation is likely to end up much lower than initial expectations, as government has steadily been reducing retail POL prices in line with international prices.
Headline inflation reached 13-year low of 4 percent in November and 4.3 percent in December, pushing down the July-December inflation to only 6.1 percent, against the full-year target of 8pc.
In addition to fuel prices, low inflation was realised by deflation in some key food items, like wheat, wheat flour, onions and tomatoes, said the report, adding that households anchor their inflation expectations on energy and fuel prices.
“Based on these factors, we expect the full-year inflation to stay within the range of 4.5-5.5pc in FY15,” said the SBP report.
The report also said the prospects of achieving the FY15 GDP growth target was hindered by a slowdown in Large Scale Manufacturing (LSM) and a below-target performance of Kharif crop.
The government envisaged GDP growth of 5.1pc for FY15.
With inflation rates on the decline as well, consumers are likely to be spending more as the value of the currency is likely to increase. By doing so, the economy too would be stimulated and revenues would be earned from the products being sold to consumers. With reducing inflation comes a higher demand and thus the economy too gets stirred into more production and manufacturing.
It is, however, important to note that while the reduction in oil prices have caused inflation to decline and produced an overall positive outlook, it does come with risks to future inflation as well. The speed and intensity with which the rate of inflation fell and continues to fall can lead to a great deal of consumption with consumers expecting the rate of inflation to continue to decline. Thus while the reduction in the prices of goods is to bring forth a great deal more spending from consumers, inflation can remain low as long as the aggregate demand and supply continue to remain in line.
While on the one hand real disposable income of households will increase, it will also reduce the input cost for industries and this development may cause credit growth and deposit growth to spur directly only if economic agents can save additional income in banks which could lead to banks having greater amount of resources to lend out. It could, however, also indirectly lift credit demand, if householders were to increase their consumption and an improved profitability would allow businesses to borrow more to meet the additional demand.
Furthermore, the lower amount of government borrowing from the banking sector has had a role to play as well which has partly been owed to better fiscal consolidation efforts on the government’s part which has helped in keeping inflation under check in two ways. Firstly, it caused the money supply to shrink, which directly affected inflation and secondly, it anchored future inflationary expectations to impact the current inflation in the manner which was desired. Additionally, improved external financial of the fiscal gap also supported the stability of the exchange rate, which contributed towards easing the pressure on the domestic prices of imported products.
A reduction in the discount rate brings down the cost of bank borrowing for manufacturers, industries, business houses thus making goods and services cheaper which results in increased buying activity on behalf of the public thereby boosting trade and economic activity.
Thus if the discount rate is kept at 8.5% then there is quite positive chances of stable economic activity within the country and remaining at a steady pace This will in addition bring forth even more positive elements to the economy and cause the economy to perform well.
