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The tightening cycle has already started without jacking up the interest rates. The rupee depreciated by 5 percent against USD in December; and recent USD weakening against global currencies is making Pakistan’s depreciation even more effective. And the good news is that this round of deprecation would have less inflationary consequences; and less chances of monetary tightening to start tomorrow.

The economic authorities decided to keep sticky currency against USD back in March 2014 and kept it virtually unchanged for a little over two years. It was the time when USD was strengthening against many of Pakistan’s trading partners, which had resulted in sharp appreciation in real effective exchange rate (REER) in Pakistan.

The REER was 101 in December 2013, when Dar hinted to tighten his grip on currency; and he did that successfully. The trading partners’ currencies kept on falling against USD and PKR kept on artificially strengthening against them. The REER kept on appreciating and it peaked at 127.4 in May 2017 and the latest published number is 124.1 in November 2017.

Now with currency down by 4.7 percent in the last six weeks against USD; the fall is much higher versus some other currencies - 10.3 percent against GBP, 9.6 percent versus EUR and slide of 7.8 percent against JPY. The REER is expected to move back by 7-8 percent to 115 levels by January end.

Now this will surely help restore some of our lost exports; especially in the European region. And more importantly, this may help curb imports, including increasing automobile imports from Japan. To give a REER perspective on trade, exports reached $25 billion in FY14 during which REER averaged at 104 and since then, it’s on the southward journey to come down to $21.9 billion in FY17 with REER average of 125.1. The story of imports is no different, the toll increased from $41.7 billion (FY14) to $48.5 billion (FY17). There are already signs of exports picking up as the number for 1HFY18 is $11.8 billion, up by 11 percent YoY. The number is likely to be higher in 2HFY17 due to exchange rate moving towards equilibrium.

Thus, exports are picking up and the fruits of real currency alignment are likely to be reaped soon. The problem is with imports which may not come down much due to currency adjustment. The imports are up by 19 percent (YoY) in 1HFY18 and it is hard to curb the toll in second half due to higher oil prices and growing machinery imports.

Therefore, the need is to ‘do more’ to put brakes on imports. The economy is likely to continue its growth momentum of 5 percent plus in FY18; and that is spurring imported demand for raw materials imports in domestic production, machinery imports for expansion and generally higher imports in oil and other items to fulfill growing consumer demand.

The consumer demand can be dealt by monetary tightening. The growth in automobiles and a few other items can be checked by increase in the interest rates. The SBP is announcing its monetary policy today. Let’s see what decision the central bank would make. The foremost variable the SBP would consider in making the decision is inflation.

The CPI is at comfortable levels - the headline inflation averaged at 3.8 percent in 1HFY18 while the core inflation is at 5.5 percent (trimmed core:4.7%) . The 12 month moving average for CPI and core is at 4.1 percent and 5.4 percent respectively. Seeing merely inflation, the SBP should be comfortable keeping policy rate intact at 5.75 percent. The question is what would be the impact on inflation due to recent round of depreciation which is higher than 5 percent for many trading partners. Well, the good news is, this time inflation would remain partially isolated to currency depreciation (for details read ‘Impact of currency depreciating’ published on December 14, 2017). There is a supply glut in key food items such as wheat and sugar in Pakistan to keep price hike in check as food and agriculture commodity prices in Pakistan are higher than international levels to remain unaffected by downward movement in currency.

Hence, the SBP may like to see the impact of depreciation both on trade and inflation before taking the hawkish stance. BR Research has conducted a market survey on monetary policy expectation. Out of 17 houses contacted, 15 expect no change, while two expect a rate hike of 25 bps. Most opine the inflation still offers enough room to continue at current rate. Others think the current government may not want to do it, and leave it for the interim.

In the previous MPS, all the nine members voted for no change; and it is highly likely that status quo would be the order of day. Yes, a member or two could raise voice of starting tightening to curb imports; but majority would think otherwise.

BR research is of the view that interest rates should move up by 50 bps by July and 100 bps by December. The way it looks, the interest rate tightening may start by March; till then see the wonders of REER adjustment towards its real value.

Copyright Business Recorder, 2018

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