The recent 250 basis point (bps) policy rate cut by Pakistan’s central bank to 15% marks a substantial shift in the country’s economic strategy, going beyond the market’s expected cut of 120-150 bps. This bold move aims to lower the government’s borrowing costs significantly, which could have far-reaching effects on Pakistan’s fiscal health and economic stability.
Key Outcomes and Macro Impacts
1. Immediate Reduction in Debt Burden
The rate cut is expected to reduce Pakistan’s FY25 interest payments by approximately Rs 1.3 trillion, bringing total interest expenses down to around Rs 8.5 trillion from the budgeted Rs 9.8 trillion. This relief, amounting to about 1% of GDP, could meaningfully help Pakistan manage its fiscal deficit by easing debt servicing costs, which is the largest drain on country’s fiscals. With further easing expected ahead, the fiscal room should be even better, estimated to be over Rs 2.5 trillion or about 2% of GDP.
2. Improved Fiscal Management
With savings from interest cuts and timely debt profiling (domestic debt) through surplus funds available, fiscal discipline appears to be strengthening. A prudent approach to these savings could allow Pakistan to maintain a fiscal deficit much lower than the originally estimated 6.9% of GDP (or Rs 8.5 trillion), with projections now suggesting the deficit could be as low as 5% of GDP, or under Rs 6 trillion – a historic low.
3. Inflation and External Account Stability
Fiscal discipline and prioritizing productive spending can help control inflation by reducing reliance on new debt, thereby containing money supply growth. This stability should also benefit Pakistan’s external account, potentially strengthening the rupee and higher foreign reserves (improved import covers and external buffers).
4. Declining Global Oil Prices and Lower Business Costs
The combination of lower policy rates and decreasing global oil prices can drive down the cost of capital, easing operational costs for the private sector and government alike. This could spur investment, improve business confidence, and help lower energy prices, setting the stage for economic growth.
5. Enhanced Investment Climate with Tax Reform
To sustain growth, Pakistan should expand and diversify its tax base, targeting untapped sectors like agriculture, retail, and property. Easing the tax burden on the formal sector would create a more conducive environment for new investments, offering the economy a much-needed boost.
In sum, this rate cut could serve as a stepping stone towards improved fiscal and economic stability, with the potential to reduce fiscal deficit, control inflation, stabilize the external account, and create a more supportive environment for growth. If paired with continued fiscal reforms, these changes can help position Pakistan for a more robust economic future.
6. Investment Strategy
As for investment strategy, various asset classes stand well-positioned for growth in this favorable economic environment. Domestic equities are expected to continue their positive performance, aligning with our forecasts in the September 2024 Strategy Report – A Path to Growth amidst Challenges. Pakistan equities since then have rallied 12.5% to date, while market’s forward multiple still tradess around 6x, which is deep discount to historical average.
With lower interest rates enhancing liquidity, the equity market, especially sectors linked to infrastructure, financial services, and consumer goods, offers attractive returns. Additionally, government bonds benefit from stable fiscal policies, providing steady income opportunities. Real estate also looks promising given reduced cost of capital and better growth prospects, making it a viable long-term asset for investors seeking stable returns in a growth-focused market.
