MPS: A test for the central bank

The current account has registered a surplus in the first half of this fiscal, foreign exchange reserves have held steady over the past two months while the local currency has also held off the century mark against the US dollar.
The average inflation rate over the past seven months is about 120 basis points lower than the going discount rate in the country. Does the situation warrant another downward revision in the upcoming Monetary Policy, which will be the last under the current political dispensation?
Lately, the doves have dominated at the central bank. The discount rate has been slashed by no less than 250 basis points since the start of the current fiscal. This monetary easing has even surpassed the expectations of most independent analysts.
However on the other hand, the inflation snake has raised its head again off late. Last months inflation tally notched up slightly and trimmed core inflation is close to 10 percent; already above the discount rate.
The International Monetary Fund (IMF) has also weighed in, albeit furtively, through its meeting with local journalists in Islamabad, last month. A large chunk of payments to the Fund are expected, this month. A return to the IMF window is also imminent, which will undoubtedly come with a laundry list of austerity measures and reforms.
Then there is the runaway Government borrowing to consider. Despite a sizeable rate cut, growth in money supply has not been tamed; neither have any significant efforts to rein in the fiscal deficit been forthcoming.
M2 has grown by 7.2 percent, so far in FY13 as compared to 4.3 percent in the corresponding period of FY12. To add to the ado, this growth is heavily skewed towards government borrowing. Since the private sector has largely missed out on credit from banks, a giant question mark looms over the efficacy of a rate cut, for private sector credit off take.
The net foreign assets (NFA) to net domestic assets (NDA) ratio which is deteriorating fast may be a harbinger of coming inflation too.
The increase in inflation reported during January has been largely attributable to recent increases in the price of wheat and associated products. That effect may cascade to other items as well, in coming weeks, so a second round of inflationary pressures cannot be ruled out.
Market has incorporated these fears in its expectations. Treasury bill auctions lately have not seen yields dropping while yields in the secondary market have also stayed flat.
A survey conducted by BR research asked banks and brokerage houses of their expectations from the upcoming MPS announcement. Ten out of 14 respondents in that survey expect SBP to maintain the status quo on the discount rate, while four expect a reduction of 50 basis points.
In our view, all the arguments detailed above point towards the maintaining of the discount rate at its current level, in the MPS announcement scheduled for tomorrow.
That said, the Ministry of Finance may be pushing for one last rate cut before those at its helm vacate the office. The decision to be announced on Friday will be a test for the central bank and its independence.