Pakistan will experience the lowest growth rate in the region in fiscal year 2020 (ending 30 June 2020) at 2.4 percent, lower than Afghanistan's 3 percent, Sri Lanka's 3.3 percent, Maldives' 5.5 percent, Nepal's 6.4 percent and India's projected growth of 6.9 percent as per data released by the World Bank. Bangladesh and Bhutan will register a growth in excess of 7 percent.
Disturbingly, Pakistan is projected to retain this distressing position in 2021 with 3 percent growth rate, followed by Afghanistan's 3.5 percent, Sri Lanka's 3.7 percent, Maldives' 5.6 percent, Bhutan's 5.90 percent, Nepal's 6.5 percent and India's 7.2 percent. The reason for continuing low growth in Pakistan as per the World Bank is because "monetary policy (will) remain tight, and the planned fiscal consolidation will compress domestic demand. The program signed with the IMF is expected to help growth recover from fiscal year 2021-22 onwards," (fiscal year 2022). There is supporting evidence that private sector activity, specifically large scale manufacturing sector (LSM), is continuing to register negative growth with a consequent rise in unemployment levels while the undervalued rupee is fuelling inflation with serious, if not severe, political implications for the ruling party.
Many independent economists hold the State Bank of Pakistan (SBP) responsible for the continuing decline in private sector economic activity and point to (i) an undervalued rupee and (ii) a prohibitively high discount rate which is deterring private sector borrowing as 'over corrections' of IMF prior conditions. And marvel as to how the Prime Minister has allowed SBP to support an undervalued rupee with obvious inflationary implications while targeting inflation by a 13.25 percent discount rate that has choked off private sector activity. SBP governor Dr Reza Baqir claims success by releasing figures that show a declining trade deficit, (but is silent on the fact that this decline is at the cost of lower imports of raw materials and semi finished products resulting in industrial unit closures and/or lower output) while stating that linking the discount rate to Consumer Price Index (CPI) rather than core inflation as in the past (which does not take account of food and energy prices as they are not items whose price is affected by manipulating the discount rate) would ensure a positive real rate of return. The question is whether the high discount rate is an over-correction?
Dr Baqir raised the discount rate to 12.25 percent, the precise rate stipulated in the IMF documents on 21 May 2019, fifteen days after he was appointed Governor and nine days after the staff level agreement with the IMF was reached. In May core inflation was at 7.2 percent while CPI was 9.11 percent implying a discount rate differential of 5.05 percent with core inflation and 3.14 percent with CPI. What has been severely criticized by domestic economists is Dr Baqir's decision to raise the discount rate by another 100 basis points to 13.25 percent in July. The core inflation in July was 7.85 percent, while the CPI was 10.3 percent or the discount rate differential with core inflation in July rose to 5.4 percent and declined to 2.95 percent with respect to CPI. In other words, Dr Baqir merely followed the spirit of this 'prior' condition, without taking account of its impact on growth, though the actual differential between the discount rate and CPI narrowed between May and July by 0.19 percent.
In his interview to Bloomberg on Thursday, Dr Baqir stated that "Pakistan must negotiate the threat of a slowing economy while seeking to lower inflation," thereby as per Bloomberg 'signaling an extended pause in the interest rate-hike cycle'. One would be hard pressed to agree with Bloomberg's assessment given that the projected rate of inflation is 13 percent for the year which would require a rate rise well before the end of the calendar year (31 December 2019) rather than fiscal year (30 June 2020) unless the business community succeeds in convincing the powers that be that this policy is economically untenable.
Dr Baqir so far has succeeded in convincing key members of the National Development Council (NDC), whose terms of reference are to set policies and strategies for development and 'formulate and tailor policies to achieve accelerated economic growth', of which the Chief of Army Staff is also a member, that the rate is appropriate. The question is how come given the slowing down of the economy with extremely worrying political implications?
At another interaction with the business community Dr Baqir reportedly advised that if the discount rate is high then those hoarding dollars may convert them into rupees and use that amount to fund their economic activity. Sources further reveal that in Dr Baqir's estimation there is dollarization of the economy and in discussions with members of the NDC he has argued that a high discount rate would compel all those who are hoarding dollars to convert them into the local currency. He reportedly does not advise freezing dollar accounts a policy implemented by Nawaz Sharif government in the aftermath of the nuclear blasts with a devastating impact on the economy.
There is no conclusive empirical evidence to date of a linkage between a high discount rate and lower dollarization. Additionally, there is no evidence that Pakistan's household sector, even those operating in the parallel illegal economy, is engaged in saving in dollars for had that been the case there would have been a surge in the dollar value versus the rupee in the open market which is not the case as the open market is shadowing the managed erosion of the rupee by the SBP - managed because the rupee is undervalued.
A high discount rate is not increasing domestic savings either because of the high rate of inflation and with unemployment and a reduction in the workforce in LSM, small and medium enterprises, the private sector was unable to raise salaries' to keep pace with inflation (though they have been raised in the public sector). In effect, the government's enhanced budgeted expenditure (both current by around 30 percent barring defence) and development will continue to be met through borrowing domestically (which at the current high discount rate would be higher than what was budgeted) and through foreign borrowing (to the tune of 38.6 billion dollars by the end of the IMF programme as per the economic team leaders).
So what exactly is Dr Baqir's objective with respect to a high discount rate? Net reserves held by the private sector in banks which are in any case accessible to the government as on 4 October were 7.235 billion dollars - a small decline from August's total of 7.36 billion dollars.
The question is what has changed since the discount rate was raised to 13.25 percent? Hot money to the tune of 300 million dollars has entered the Pakistani market, not enough to make an appreciable difference in the SBP reserve position, but at a cost that is extremely high for the country.
To conclude, the existing implementation of two of the IMF prior conditionalities by the SBP require urgent remedial measures not only for economic reasons but also for political reasons.
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