Change in policy rate expectations

Minutes of the State Banks monetary policy committee meeting held in May aren out yet. But there are reasons to believe - based on the underlying tone of the banks latest policy note and the voting behaviour - that moods are turning in favour of higher interest rates.
In March seven out of the nine members were present; five voted to maintain status quo and two favoured a hike. In May, however, all nine members attended the meeting and reportedly the vote was likely split 5:4.
This somewhat corresponds with the views of senior policymakers - including former SBP governor, former finance ministers amongst other senior economists - interviewed by BR Research; and four out of five senior economists think that there will be some monetary tightening in FY11.
The reasons cited by them vary from supply-side inflationary expectations arising from the withdrawal of subsidies and commodity price risks, to demand-driven inflation, which is seen stemming from high powered money creation for expected fiscal gap, and to attract domestic savings at lucrative rates to finance fiscal slippages.
Moreover, globally, the talks of gradual removal of fiscal and monetary stimulus in the aftermath of Euro-zone crises are heating. Though, some economists believe that moving away prematurely from this Keynesian solution, when private investment has not picked up, may turn the recession into a depression, a Greece like crisis situation is nonetheless haunting G20 leaders.
Even the region has started monetary tightening as India marginally increased its policy rate to curb high inflation.
Interestingly, this comes in contrast to the only contrarian view held by one of the five senior economists, interviewed by BR Research, who was in favour of a rate cut in Pakistan while citing that SBP should follow the Indian central banks approach of giving more weight to private sector than food inflation.
Recently, analysts at brokering and banking companies are also gradually changing their stance from softening expectations to the risks of further tightening. Its herd mentality, like everywhere in the world, but expectations are changing direction around every corner.
Knowing that SBPs decisions have been, by and large, in line with market expectations, especially since the crisis of 2008, the rate hike could be on the cards; and there are all the right reasons to believe so.
The consolidated budget numbers right from the start of the fiscal year appear to be way out of proportion.
Like the federal government, fixed consolidated budget deficit at 4 percent of GDP (Rs685 bn) is based on the assumption of a surplus of Rs167 billion (1% of GDP) from provinces. But the provinces are showing a deficit to the tune of Rs50-70 billion, which can take the consolidated deficit around Rs900-920 billion (5.2-5.3% of GDP).
Now the question is how to finance this deficit; for the targeted 4 percent of GDP, the government is already eyeing Rs186 billion from external flows and Rs499 billion from domestic sources. Within the external flows, Rs43 billion is envisaged from a Euro bond issue which seems optimistic under Pakistans current global credit rating and the roaring sovereign defaults in the international market.
So the onus of fiscal financing is growing more and more on domestic sources, which strengthens the case for higher interest rates.
Now, in order to attract money from non-banking as well as banking channels, the government needs to offer higher rates on NSS and T-Bills respectively. This expansionary fiscal pressure will exert enormous pressure on the monetary policy committee.
One can argue that government expenditure - apart from what ought to be spent on foreign debt servicing amid a ceiling on fiscal borrowing from central bank - will not have much effect on the overall quantum of money supply in the country.
Also higher inefficiencies in public sector spending, crowding out of private sector and lower federal development expenditure cast doubts on the output growth targets of the economy. This implies sticky aggregate supply but with risks of higher aggregate demand. In other words, the signs are visible even for those who have their eyes wide shut.