What keeps the rate cut at bay?

Pakistans current account gap has been tamed to a point of possible surplus in May; sanity has returned back to rupees parity with the greenback; and Europes debt contagion has pushed global commodity prices to multi-month lows.
All of this is enough fodder for the analyst and business community to hope for a downward revision in discount rates. At the least, some might be expecting a softer tone by monetary managers on Monday, with all bets on status quo as regards the interest rate.
However, these expectations could be slightly off.
Thats because they are probably not looking at the central bank close enough to see how its controlling aggregate demand through pricing power while keeping a critical eye on exogenous aggregate supply.
In an interesting development last week, the government revised its growth estimates upwards to over 4 percent from 3-3.5 percent, by revising down previous two years numbers. That, however, places the output (at factor cost) below the levels earlier projected.
Also the discrepancies in methodology, especially in SMEs and livestock sub-sectors, might further dent money managers confidence over the numbers computed by their fiscal counterparts.
This simply implies that the supply is increasing at a rate lower than earlier estimated by SBP in its first half report.
Thus, any drop in the growth of money supply - a proxy for aggregate demand - might not reduce the demand-supply gap that central banks across the globe see as the main culprit behind higher prices.
One may argue that higher inflation in the last two years is mainly driven by cost push factors; and that falling commodity prices and lower external gap should persuade money managers to give a breathing space to industry by lowering interest rates.
However, a close look at the components of money aggregates, which is an indigenous variable, reveals the other side of picture -- a darker side.
At the peak of foreign inflows when Net Foreign Assets (NFA) were close to the trillion rupee mark, the ratio of Net Domestic Assets to NFA was close to 3 in June 2007, whereas inflation was around 7 percent at that point.
In FY08, the financial crisis caused a flight of capital while the government kept on printing money to feed its domestic demand that doubled the ratio of NDA-to-NFA by June 2008. Resultantly, inflation soared to 20 percent. The ratio hit its worst level of 14 in November 2008 - just months after inflation peaked to 25.33 percent in August.
This imbalance in monetary aggregates not only triggered inflation but also changed the dynamics in other price factors i.e. rupees parity against its trading partners. Therefore, the SBP was left with the third pricing factor - interest rates - to contain the other two variables by narrowing the aggregate supply-demand gap.
Now, the latest monetary numbers show that the critical ratio is still hovering around 8.5.
This means that, although, current account deficit isn threatening in the short-term, domestic liquidity, relative to foreign inflows, is still high enough to trigger external imbalances.
Had the discount rate been high too, this vulnerability could have been checked; but the reality is that the rate is only marginally higher than what it was in June 2008.
The fiscal pressures might subside partially due to IMFs condition on the printing of money. However, the quasi fiscal financing for commodity operations - thanks to international and local price distortions - and the energy circular debt has SBPs hands tied up.
The central bank is well aware of the trading nature of Pakistans economy amid supply side bottlenecks. Any quantitative easing might put pressure on domestic pricing while triggering imports at the same time, which in turn can weaken the exchange rate. These factors, coupled with the fact that Pakistan will have to make loads of foreign debt repayments in the second half of FY11 and FY12, the chances of further tightening cannot be ruled out on Monday.