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EDITORIAL: The Monetary Policy Committee (MPC) of State Bank of Pakistan left the discount rate unchanged at 7 percent, widely expected given the onslaught of the third wave of Covid-19; however, the projection for the growth rate was revised upward to 3 percent “reflecting in part the monetary and fiscal stimulus provided during Covid.” Core inflation (non-food and non-energy on which the discount rate has no effect) in February 2021 was 6.4 percent year-on-year while Consumer Price Index (CPI) was 8.7 percent last month year-on-year which indicates that the SBP may have reverted to the policy of linking the discount rate to core inflation instead of the CPI – a decision implemented from 6 May 2019 till March 2020 that had disastrous consequences for the large-scale manufacturing sector. The rate was reduced to 7 percent over a four- to five-month period. While acknowledging that the government and SBP undertook expansionary policies to deal with the pandemic, yet, there is considerable speculation that there will be policy reversals in the light of recent upward revision of tariffs (utilities) and withdrawal of exemptions (overestimated by the Federal Board of Revenue from between 70 to 140 billion rupees with sources within the Board revealing no more than 30 to 40 billion rupees on condition of anonymity) as part of “prior” conditions agreed under the staff-level agreement on the second to fifth review reached with the International Monetary Fund on 16 February 2021. This was endorsed in the Monetary Policy Statement (MPS) issued by MPC: “given that fiscal policy is expected to remain contractionary to reduce public debt the MPC noted that it was important for monetary policy to be supportive as long as second round effects of recent increases in administered prices and other one-off supply shocks do not materialize and inflation expectations remain well anchored.” In this context, Business Recorder would urge a revisit of the existing discount rate on the grounds that the linkage with core inflation can be fully supported during normal times while the pandemic has globally imposed abnormal conditions that necessitate a further reduction.

The SBP has projected a growth rate of 3 percent but added that the MPC “took note of the uncertainty around the inflation and growth outlook.” The budgeted growth projection was 2.1 percent (May 2020), while multilaterals projected the rate for the current year at no more than one to 1.5 percent with the IMF website currently projecting growth rate for 2021 at 1.5 percent and inflation at 8.8 percent. Two observations are in order. First, the growth rate on the strength of LSM data (July-January) reveals the largest growth in food, beverages and tobacco sector (3.69 percent cumulative year-on-year and 5.12 percent monthly) and yet food inflation remains in double digits followed by non-metallic mineral products registering 2.7 percent growth (cumulative year-on-year) and 3.52 percent monthly on the back of considerable incentives/exemptions to the building industry. All other sectors registered a growth of less than 1 percent (cumulative) with automobiles, showing a 1 percent growth in January. Textiles registered a 0.73 percent growth, pharmaceuticals 0.94 percent, fertilizers 0.42 percent while there was a decline in production of iron and steel, electronics, leather, paper and boards, engineering and rubber products. The MPC however had more up-to-date data available and noted that LSM rose by 9.1 percent year-on-year in January 2021 against a contraction of 3.2 percent in January 2020 (mainly attributed to the discount rate of 13.25 percent).

The question that arises is what did the MPC base its higher growth rate projection of 3 percent on? Undoubtedly, it was the Business Confidence Survey (BCS) that for December 2020 noted that the index increased by 5 points. However, the linkage between the BCS translating into an improvement in the LSM has been tenuous at best: BCS noted that confidence rose from 48 in October 2019 to 52 in December 2019; however, LSM data revealed that it plummeted by negative 5.59 percent in January 2020 and negative 0.2 percent in February 2020 (pre-Covid).

With respect to inflation, the SBP disclaims all responsibility by stating that “while noting that the recent increase in inflation is primarily due to supply side factors the MPC also highlighted that the output gap is still estimated to be negative, core inflation continues to be relatively subdued, and inflation expectations – while drifting up somewhat due to recent increase in headline inflation numbers – are still well anchored.” Two observations are in order. First, the SBP has rightly indicated that its ability to check inflation is limited to the LSM sector (and not due to supply side factors including raise in tariffs, shortages in production of major crops, the price manipulation by middlemen/wholesalers/retailers); however, the SBP amendment bill approved by the cabinet lays full responsibility for checking inflation on the SBP. This amendment is all the more inexplicable because Pakistan has a large informal sector which runs parallel to the legal economy on which the discount rate has no impact.

Secondly, while the GDP projection varies significantly between the SBP and the multilaterals yet inflation appears to be in synch – 8.7 percent in the first eight months of the year and 8.8 percent projected by the IMF. Sceptics argue that this may be because the economic team leaders do not take any ownership for inflation by accusing the mafia operating in productive sectors (wheat, sugar, cement, etc.), seasonal fluctuations in supply and on provincial governments for failing to undertake appropriate administrative measures.

Copyright Business Recorder, 2021