KARACHI: The State Bank of Pakistan (SBP) on Saturday reduced its policy rate by 50 basis points to 9.5 per cent effective Nov 17 for two months, after keeping it unchanged at 10 per cent for the last one year.

The central bank in its Monetary Policy Statement cited some strong reasons for the cut including low inflation and falling commodity prices on the international market.

The last change in the interest rate was introduced in November 2013 with an increase of 50bps to 10 per cent.

“Given its recent downward trend, the likelihood for inflation to end the current fiscal year on a lower plateau is high,” said the SBP.

However, the bank has enlisted a number of risks that may affect the monetary situation. First, downward trend over the medium- to long-term remains to be seen because it is based on volatile prices of “perishable items” and “oil”.

Secondly, other risks identified in the previous statement such as cut in subsidy to electricity and levying of Gas Infrastructure Development Cess, still hold and if materialised can alter the inflation outlook on a higher side.

Third, underlying inflationary pressures on core inflation remain.

The SBP said the current low oil price could salvage some of the lost growth momentum. Broadly, however, growth in Large-Scale Manufacturing (LSM) would remain constrained due to energy bottlenecks. Thus the main thrust to the growth momentum would come from agriculture outcomes in the remaining months of this fiscal year.

The SBP said the government had shown a significant progress in curtailing budgetary imbalances. “It seems on course to achieve further fiscal consolidation, given its current management of expenditures and borrowing pattern.”

This has positive implications for the monetary management and more importantly, in the coming months, it would have a favourable impact on the private sector credit cycle.

However, to achieve fiscal consolidation in the long run, structural reforms to broaden the tax base remain imperative, said the SBP.

Low oil price along with falling inflation can improve competitiveness of Pakistani exports. Imports, on the other hand, might take advantage of low global commodity prices and increase further in the rest of FY15.

The State Bank believes the trade deficit is expected to remain under pressure and the healthy growth in workers’ remittances would continue to assuage the weaknesses in current account deficit to some extent.

The SBP said it is important to observe the role of foreign exchange inflows in domestic liquidity creation which helps the banks to extend more credit to the private sector.

“This happens as government gets the space to borrow less from the banks, thereby leaving more liquidity for credit expansion,” said the SBP, adding that in response to various recent and ongoing efforts of the government, foreign exchange inflows would remain on track.

Published in Dawn, November 16th, 2014