EDITORIAL: The Monetary Policy Committee (MPC) in its statement dated 22 January 2021 decided to maintain the policy rate at 7 percent, as per market expectations. However, the statement cautions that notwithstanding favourable growth and inflation developments considerable uncertainty remains around the outlook mainly sourced to Covid-19 with an emphasis on external shocks. This warning has fuelled apprehension in the market that the next MPC meeting would possible raise rates – a view strengthened by the statement that “as the recovery becomes more durable and the economy returns to full capacity the MPC expects adjustments in the policy rate to be measured and gradual to achieve mildly positive real interest rates.”
A positive real interest rate is achieved when the rate of inflation is less than the discount rate. Today the discount rate is 7 percent, the consumer price index is 8.4 percent to which the discount rate was pegged from May 2019 to March 2020 or pre-Covid-19, the core inflation with which the discount rate was pegged pre-May 2019 is 5.6 percent. This implies that today the real interest rate is more than in “slightly negative territory” which strengthens market perception that the rate may well be raised in the next MPC meeting. How gradual it would be would depend on the agreement with the International Monetary Fund (IMF). It is also relevant to note in this context that the use of the term “full capacity” for the Pakistan economy is perhaps not appropriate given the underperformance of the energy and tax sectors in particular.
A favourable growth projection noted on the statement is no doubt sourced to an increase of 7.41 percent July-November 2020-21 in Large Scale manufacturing (LSM) compared to July-November 2019-20 – an upswing that has been publicized by the Prime Minister as well as his cabinet. However, two elements have been ignored with respect to a comparison with the comparable period 2019-20. First and foremost, the low growth in July-November 2019, pre-Covid-19, was due to the severely contractionary monetary (and fiscal) policy being implemented which on the monetary side included: (i) 13.25 percent discount rate that stifled productivity in the country while attracting “hot money” which, as was feared by Business Recorder, left the country in a hurry; (ii) the rupee rate has stabilized, as per SBP in its post MPC meeting press conference, indicative of success of SBP decision to implement a market based exchange rate. In this context it is critical to emphasize that while a market-determined rate brooks no interference in the market by the central bank yet Pakistan adopted market-based rate, as agreed with the International Monetary Fund on 12 May 2019, (primarily to protect from it from being manipulated), which allows for SBP intervention and there are credible reports that SBP does (when it feels the need to) intervene in the market to stabilize the rupee to contain the fiscal deficit.
The budgeted growth rate of 2.1 percent for the current year and the ‘favourable growth projection” by the MPC is no doubt premised on the recently released July-November Large Scale Manufacturing growth rate of 7.41 percent compared to July-November 2019-20. What is ignored is the SBP figure for April-June 2020 with negative LSM growth rate of 24.8 percent or, in other words, the base was so low that an increase of 7.41 percent did not bring us to the 2018-19 level. One would, however, extend appreciation for the SBP not basing its higher growth projection on the Business Confidence Survey results as in previous statements given that the survey results are not easily available on its website. It is relevant to note that multilaterals, including the World Bank, are projecting a growth rate of around 1 percent for Pakistan in the current year and while the IMF has yet to update its projection which no doubt would be uploaded as and when the staff-level agreement on the second quarterly review is reached, yet it is perhaps safer to assume that the multilateral rate would be achieved given Pakistan government’s agreement on specific time-bound structural adjustments.
The MPC also notes that “inflation pressures have eased since the last MPC, despite an upward adjustment in fuel prices…. After remaining close to 9 percent in the preceding two months headline inflation fell to 8.3 percent in November and further to 8 percent in December, the lowest level since June 2019.” However, it is unclear whether the MPC focused only on the upward adjustment of fuel prices in December 2020 or whether it deemed it appropriate to include the little more than 3 percent rate rise in January 2021 and with no mention of the raise in electricity prices by 1.99 per unit last week critics may challenge the inflation projection as already becoming irrelevant.
The statement noted foreign exchange reserves of 13 billion dollars, their highest level since December 2017. However, the statement did not indicate that more than half of the reserves are from borrowing, including (i) deposits from another central bank or a swap arrangement with China which are a liability, and (ii) foreign currency swaps with commercial banks that again are not listed as liabilities.
The economic situation has certainly improved since April-June 2020 yet it has not yet achieved the levels it should have based on considerable easing of monetary and fiscal policies that began in March 2020 and continue to this day though some of the incentives, particularly in relation to gas availability to the productive sectors, remained compromised in January 2021. However, it needs to be noted that reforms relating to full autonomy for SBP agreed with the IMF, have yet to be fully implemented and the central bank operates under considerable economic and political pressures and this continues to this day in spite of pledges made to the IMF that the apex bank has been granted full autonomy.
Copyright Business Recorder, 2021