EDITORIAL: The Monetary Policy Committee (MPC) decision to keep the policy rate unchanged at 7 percent has come as no surprise. The reason for this expectation was based on two divergent theories. The first one with more traction is the contention that the ongoing negotiations with the International Monetary Fund (IMF) on the second mandatory review (overdue for completion since before Covid-19) require that there be no further easing. The Fund as a pre-Extended Fund Facility programme condition required the MPC to raise the discount rate to 12.25 percent, a condition met on 21 May 2019 and on 20 July 2019 the rate was raised further to 13.25 percent with the overall objective of the SBP to “focus on reducing inflation, which disproportionately affects the poor, and safeguarding financial stability,” as stated in the 12 May 2019 staff level agreement press release uploaded on the IMF website. The decision to raise the discount rate together with a severe contractionary fiscal policy envisaging the unrealistic 5.5 trillion rupee tax collection had a massive negative impact on: (i) inflation, projected by the IMF to rise from under 7 percent in 2018-19 to 13 percent last year though actual inflation is estimated at around 11.2 percent; (ii) a contraction in the productive sectors that laid off at least 50,000 employees (pre-Covid-19) thereby raising poverty levels and rendering the enhanced Benazir Income Support Programme unable to meet the rising needs for cash disbursements. In defense of a discount rate close to the projected, as opposed to the actual rate of inflation for the year, SBP Governor Dr Reza Baqir stated that the discount rate was linked to the consumer price index, which includes items not responsive to the discount rate, instead of to the core inflation as in the past.
In the Rapid Financing Instrument documents dated April 2020 uploaded on the IMF website the authorities pledged to that “SBP’s policies will remain centered on bringing the inflation down to the medium term objective of 5 to 7 percent” – mention of the medium term allowing the SBP to take heed of the IMF caution for the need to remain vigilant of potential inflationary pressures and to ensure that “regulatory measures and expanded refinancing schemes must be targeted and temporary and their design should not create moral hazard nor foster poor credit risk management practices.”
By March 2020, the SBP would almost certainly have been facing considerable heat due to Covid-19 as well as from the political leadership grappling with the reservations of the influential LSM sector suffering a decline in productivity and the rise in inflation prompting a marginal reduction in rate to 12.5 percent on 18 March 2020. It took the MPC another four meetings to reduce the rate to 7 percent – 11 percent on 25 March, 9 percent on 17 April, 8 percent on 18 May and 7 percent on 26 June. The MPC on 21 September’s decision not to change the rate is in spite of a CPI of over 8 percent and core inflation of under 6 percent, reflecting a position at odds with the policy position last year as well as what is required today based on the CPI and core inflation.
The second reason for keeping the rate unchanged has been provided in the policy statement and stipulates that LSM is growing at 5 percent year on year, auto sales, cement dispatches, POL sales and electricity consumption are on the rise, though a second Covid-19 wave is a risk that would push the growth rate down from the projected 2 percent in the current year. The statement added that “taking into account the changes in the outlook for inflation and growth since the last MPC and the impact of stimulus measures undertaken by the government and SBP, and its MPC was of the view that the stance of monetary policy remained appropriate to provide needed support to the emerging recovery, while keeping inflation expectations well anchored.” Two observations on this claim, one while there are reports of a high level of export orders, SBP cited domestic sales as the harbinger of growth notably auto and cement sales – a claim that would have to be assessed by the end of the year, and second the growth projection of 2 percent does not match the IMF projection of one percent on which negotiations with the Fund are ongoing.
The 7 percent rate may be too high for the productive sectors and it is likely that political pressure may come to bear on the decision not to reduce the rate further especially given the core inflation rate being less than 6 percent. To blame inflation entirely on supply side issues, and there are significant issues there, and not take any cognizance of a discount rate may not be looking at the entire picture given that our discount rate is above the regional average as well as one of the highest in the Covid-19 world today – a factor on which exports are partly premised.
Copyright Business Recorder, 2020
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