KARACHI: The real interest rate is now above 1,000 basis points in the wake of an unexpected fall in inflation to 11.76 per cent in May.

The real interest rate is the difference between the nominal interest rate and the rate of inflation.

Higher real interest rates can raise borrowing costs and force people to curb spending and borrowing. It can slow economic activity.

On the other hand, higher rates can also improve the returns on investments.

However, the State Bank’s cautious approach has proved harmful for economic growth despite low inflation. Financial experts said the figures for inflation in May were surprising.

Experts see 200bps cut in policy rate this month

“This is a blowout number _ at least two per cent lower than what the market was expecting. A rate cut of 200bps is now a sure bet,” said the CEO of Tresmark.

“However, we believe this is a one-off and inflation for June will be around 13.5 per cent as additional revenue-related measures like GST and removal of exemptions, along with Eid-related pressures, will bump up prices,” he said.

Almost all financial experts were agreed that an interest rate cut in the next monetary policy was now a certainty.

A lower interest rate will pump money into the private sector and activate the economy, provide cheaper money to the government and help check inflation, the experts believe.

Samiullah Tariq, the head of research and development at Pak-Kuwait Investment, said since the real interest rate is higher by 10 per cent, the central bank has leeway to bring it down.

“The secondary market has already responded as the yield on government paper started declining,” he said.

The cut in the policy rate is bound to reduce the government’s borrowing load. In the first half of the current financial year, the mark-up rose by 64 per cent. The government paid over Rs5 trillion as mark-up during the first 10 months of the current financial year.

“With the expected slowdown in inflation, real rates are now significantly positive (10.2 per cent) even on spot basis. We believe that SBP should start a monetary easing cycle this month with at least 200bps reduction in the policy rate,” said head of research at Arif Habib Limited, Tahir Abbas.

With the expected interest rate cut, the real interest rate will still be as high as 8.2 per cent and the SBP stance on monetary policy would still be tight. Further cuts cannot be ruled out in the near future, he added.

Published in Dawn, June 4th, 2024