No change, as expected. Certainly the monetary policy committee has moved from tightening to holding mode. The question is when will it change gears to easing mode – for that SBP has to be certain on dividends of tightening – it is reflecting in terms of reducing current account deficit to one fourth and having a fiscal primary surplus. The most important indicator for SBP is inflation – the expectation has remained unchanged at 11-12 percent, but recent resurgence of food inflation has kept SBP in a holding mode. Nov and Dec month on month inflation numbers are key for the decision in Jan.
The SBP is cognizant of the fact that recent increase in inflation is due to supply shortage in perishable food items – tomatoes, onions and fresh vegetables. This may be a blip in an otherwise falling inflationary trend. However, if the monthly numbers remain high in next two months, this could lead the SBP to think of forming a trend. And that may change the equation altogether.
The SBP fears that if food inflation trend persists, it may lead to demand and wage inflation – since food is big part of consumption basket for low income groups. If wages rise, that will pose risks to inflation expectations, and if that is internalized into cost of production, then inflation expectations will change, and policy lever may shift accordingly.
On monthly basis, the CPI increased by 1.82 percent in Oct-19 and that buried any expectation for token decline in policy rate. The hike in food prices remained unabated in Nov based on the weekly SPI data, where combined group SPI increased by 2.3 percent in week ending 14th Nov versus the week ending 17th Oct. This implies that food prices are likely to remain high in Nov CPI readings. Seeing that, CPI is likely to be north of 12 percent year-on-year in Nov, and that one number could be enough for doves to not dominate in Jan.
However, if history of any guide, perishable food items prices may come down in Dec – it happened without exception for the past 10 years. If monthly inflation is negative in Dec, a token decline may be in sight. That would require some supply side administration measures to ensure adequate supply of perishable – the crops to arrive from Sindh have some minor issues due to higher than historic temperature in past few weeks, and from imported supply, the prices may not come down substantially. Seeing all this, more chances of rate cut are in Mar-20.
Climate change is also having its impact on crops and in recent IMF and WB annual winter meetings, the role of central banks in climate change was one topic. Reza Baqir should think of what SBP can do to mitigate the impact of climate change which is adversely impacting our agriculture economics.
Now let’s talk on what changes in the economy high rates brought. There is criticism emanating from circles that tight monetary policy is doing more damage to the economy. One element of high rates remained unnoticed by critics is how high rates have curbed the dollarization. There are signs of converting the dollars into rupees in the past few months – there is increase in time deposits of commercial banks, and decline in FE25 accounts. Plus, SBP buying of dollars has resulted in the decline in forward liabilities.
On current account both oil and non-oil deficits are falling, and that is possible due to REER movement. There are signs of both exports picking up and falling imports. This is good for market sentiments. Our real effective exchange rate which was well above our trading partners and competitors is now on the lower side of the band. That is a good sign and seeing this we can expect some pick up in exports – talks with exporters are affirming the SBP view. The key is to look for new export markets and for new sectors. We need to do away with the mindset of picking winners – ERF and LTFF should include more sectors, and incentives should to be given for those who venture into new markets.
The other milestone achieved last week is portfolio investment in government papers crossing billion-dollar mark in just five months. The potential is huge and analysts expect $3-5 billion by Jun; apart from that, the SBP may buy another $2-3 billion from the market. This $5-8 billion addition in reserves will give enough room to go for pro-growth policies in the next fiscal.
After having primary surplus in the first quarter and after meeting all the IMF targets, federal government has started releasing some funds in PSDP – that may help in achieving some economic growth. SBP has kept its growth projections unchanged at 3.5 percent for FY20; however, seeing the steep fall in LSM and poor cotton and other crops, market survey is showing growth to come down to 2.7 percent.
Seeing the improvement in business confidence survey as per SBP-IBA recent survey, momentum will build up in quarters to come. One positive element that is being missed by critics on portfolio investment in government papers is that this may help create space for private credit by commercial banks. For the past many years, owing to persistent high fiscal deficit, virtually all the banks credit is extended to government. There is no or little competition to banks – the more foreign funds participate in government papers, banks would have more liquidity to deploy to the private sector. The excess liquidity may result in low risk premium to be charged by banks on private credit. Plus, once the flows start coming in PIBs, yield curve may develop, and this will help in much needed deepening of capital markets for creating space for long term funding to private sector.
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