Pakistan's central bank, State Bank of Pakistan, cut its key interest rate by 150 basis points on Monday in a widely expected move, marking its first rate reduction in nearly four years in its effort to boost growth amid a sharp decline in retail inflation.
The decision to cut the key rate to 20.5 per cent comes two days ahead of Pakistan's annual budget and a week after data showed inflation slowed to a 30-month low of 11.8 per cent in May.
"The significant decline in inflation since February was broadly in line with expectations, (but) the May outturn was better than anticipated earlier," the State Bank of Pakistan (SBP) said in a statement.
The SBP last changed rates in an emergency meeting in late June last year, when it raised rates by 100 basis points to a record high of 22 per cent.
Economic activity slowed over the last two years in Pakistan as it implemented tough reforms under an International Monetary Fund (IMF) bailout in a bid to stabilise its crashing economy.
Pakistan's Finance Minister Muhammad Aurangzeb, speaking at a business conference in China last week, said he expected rates to come down in the face of falling inflation.
However, bank's monetary policy committee meeting said in Monday's statement that there were upside risks to the near-term inflation outlook associated with the upcoming budgetary measures and uncertainty regarding future energy price adjustments.
The SBP had raised rates by a total of 1,500 basis points between September 2021 and June 2023 to rein in high inflation.
The last hike in rates to a record 22 per cent came as the country looked to secure a short term $3 billion bailout from the International Monetary Fund in a bid to stave off an imminent default.
The global lender had stressed the importance of keeping a tight monetary policy to control inflation, which had stayed above 20 per cent since May 2022 and hit a record high of 38 per cent last year.
High rates, however, have kept government's borrowing costs elevated and with the new government looking to tighten its purse strings, lower rates will be critical in helping it reduce domestic borrowing costs.
"As anticipated, SBP has taken a step towards narrowing the real interest rate gap to stimulate the economy and reduce its debt servicing burden," Muhammad Ali, market analyst at AKD Securities, said.
GDP growth in the current financial year to June 30 is expected to be between 2-3 per cent after posting a de-growth of 0.17 per cent in FY23. The government is targeting achieving 3.6 per cent growth in the year starting July amid an uptick in economic activity.
The government is also in talks with the IMF for a longer-term bailout of around $6 billion to $8 billion for which it is expected to formally apply after the budget is passed by parliament.