PRAC Chairman Urges Lower Policy Rate to Stimulate Economic Growth

Mohammad Younas Dagha, Chairman of the Policy Research and Advisory Council (PRAC), has called on the State Bank of Pakistan (SBP) to reduce its policy rate from 19.5% to 17.5%. This proposed adjustment aims to keep the real interest rate positive, aligning with the International Monetary Fund’s (IMF) requirements and fostering economic growth.

In a press release issued by PRAC, Mr. Dagha emphasized that lowering the policy rate is crucial for achieving the government’s target of 3.6% real GDP growth. He argued that a lower real interest rate, projected to be between 2.4% and 3.4%, is necessary to sustain debt levels and stimulate economic activity. Mr. Dagha expressed concerns that the FY25 budgetary measures could drive inflation up by 3-4%, pushing it towards 15%.

While acknowledging that the SBP’s recent decision to reduce the policy rate from 22% to 19.5% was a step in the right direction, Mr. Dagha believes further reduction is warranted. He pointed out that despite a significant deceleration in inflation from 38% in May 2023 to 11.1% in July 2024, the policy rate has been cut by only 250 basis points in the past two monetary policy meetings. This reduction, he contends, is insufficient to support robust economic growth and alleviate the burden of debt servicing.

Mr. Dagha criticized the SBP’s stance on maintaining high policy rates, citing the rupee’s appreciation by nearly 9% against the US dollar and the recent decline in global commodity prices. He noted that the exchange rate had improved from $305.5 in August 2023 to more favorable levels, while petrol prices dropped from Rs318.4 per liter in September 2023 to Rs269.4 per liter in July 2024. These factors, he argued, weaken the justification for maintaining high policy rates.

The prolonged high policy rate has had adverse effects on economic activities, as evidenced by the Large-Scale Manufacturing Index (LSMI), which fell by 12.4% from 130 in January 2023 to 113.9 in May 2024. Mr. Dagha attributed this decline to high interest rates, rising energy costs, and weakened demand. Additionally, the high policy rate has strained Pakistan’s fiscal capacity, with interest payments increasing by 49.4% from FY23 to FY24, exacerbating fiscal challenges.

Mr. Dagha’s call for a lower policy rate reflects a broader concern about the impact of monetary policy on economic growth and fiscal health. The PRAC’s recommendations highlight the need for a balanced approach to interest rates to support economic stability and growth.