MPS: when the good is not good enough

The policy rate has been increased by 50 bps to 6.50 percent. Will this monetary tightening take the economy out of the mess? The short answer is no; but tightening is inevitable, as at least the decision is in the right direction.
Is the tightening too little or too late? One liner is probably; but the structural mess and unprecedented fiscal expansion resulting in ballooning current account deficit cannot be solely dealt with by rate hike. The twin deficit is fueling inflation with core inflation touching 42-month high of 7 percent in Apr 18. Had the SBP been proactive, the situation could have been better or not as bad.
The SBP''s wait and see stance in Mar 18 was uncalled for. The thinking at MPC kept on changing every two months based on short term numbers. In November 17, eight out of nine members opted for no change, while in Jan18 eight out of nine members opted for rate hike, and another 180 degree shift with six out of nine in favour of no change in May 18.
The decisions are based on recommendations of SBP''s FPAS model and judgment of monetary policy committee. The point is not to be critical on the decision; rather oscillating forecast and views on key macroeconomic variables are diminishing the importance of FPAS model.
In Jan 18, risks to stability were narrated, while the narrative was changed in March due to some better monthly numbers. There are five key macroeconomic readings between March and May statements; and none was showing any stabilization expressed in March policy and minutes.
Inflation stood at 3.8 percent in April which is not too high but the core inflation had reached 7 percent. Here, the benefit of doubt is given to SBP''s model as the house rent index quarterly increase in April, contrary to market and FPAS prediction, was too high at 3.1 percent. But there is no leeway to FPAS on under underestimating the threats of twin deficits.
The current account for March and April stood at 5.4 percent and 7.9 percent of GDP respectively - the 10MFY18 is at 5.3 percent - worst since FY09. The fiscal deficit for third quarter came at 2.1 percent of GDP to take the nine months numbers at 4.3 percent of GDP.
Did the SBP model not forecast slippages in twin deficits to warrant tightening in March? How can the forecasts and stance fluctuate every other month? Should the monetary policy and SBP''s economic model not have some long term goals and policy anchors to move on that path?
The naive part is that after 4.3 percent of GDP deficit in 9MFY18, the SBP still expects the fiscal deficit to be at 5.5 percent of GDP in FY18. The deficit is all set to cross 6 percent. Mind you, the numbers do not even include quasi fiscal debt in energy chain.
There was a time when half of the monetary policy statement used to stress on bringing fiscal discipline for macroeconomic stability. This seems to be a non-issue now with no emphasis on getting fiscal house in order. No stability can be achieved without sustaining fiscal deficit below 4 percent of GDP.
The next government''s first year will be served in straightening the imbalances, forget about agendas of economic revitalization. The modes operandi should be to undo the fiscal expansionary policies run by the last two regimes. The private credit to GDP came down from 27 percent in FY08 to 16 percent in FY17. The private sector is cash rich and looking for avenues to invest. On the flip, all the energy and other infrastructure are being built by government, leaving no space for private sector credit and investment.
The first 100 day realistic agenda of any government should be to work on policies to bring fiscal deficit down to 4 percent of GDP and pave way for private sector to invest in housing, manufacturing and other important sectors.
Once that is done, trimming current account deficit is a matter of time. But it is easier said than done. The new government will probably be tightening monetary policy further in coming reviews.