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President Tayyip Erdogan reportedly told Prime Minister Imran Khan that the 13.25 percent discount rate (effective between 20 July 2019 till 17 March 2020) would “not help develop the country”, prompting him to summon Governor State Bank of Pakistan (SBP) Dr Reza Baqir for an explanation. Baqir reportedly projected a massive fall in the Turkish lira due to Erdogan’s decision to slash the discount rate which, as it turned out, did happen.

The question is: was this correct projection indicative of the soundness of the SBP’s monetary policy and therefore endorses its 2019 to 2020 pre-pandemic decisions or was a comparison between the two countries not appropriate?

Discount rate as a monetary policy tool is mainly though not exclusively used to check inflation by mopping up excess liquidity, a primary responsibility of central banks. Turkey’s inflation rate has been a source of serious concern for the Erdogan government as it was 16.3 percent in 2018, 15 percent in 2019, 12.2 percent in 2020 and 16.59 percent in May 2021. In marked contrast Pakistan’s inflation was a lot lower than in Turkey: 4.7 percent in 2017-18, and July-April 2019 inflation was 6.99 percent. However, the agreement Dr Baqir and the then de facto finance minister Dr Hafeez Sheikh signed with the International Monetary Fund (IMF) on 12 May 2019 on behalf of Pakistan projected an inflation of 13 percent in 2019-20 subject to the implementation of the agreed conditions which the two Pakistan economic team leaders then proceeded to implement – highly inflationary conditions envisaging a significant rise in utility rates as well as taxes (indirect) as part of the agreed upfront reform agenda.

In its defence, SBP is on record as stating that the discount rate was raised as Pakistan was experiencing a net negative real interest rate defined as the discount rate being lower than the rate of inflation. This of course was not the case in May 2019 though the discount rate of 7 percent today is lower than the inflation of over 8 percent at present. This may have prompted Fitch to forecast a rate hike of only 25 basis points from the current 7 percent in 2022 (any higher rate would generate severe criticism given the impact of the pandemic on the global economy as well as on Pakistan) and the rating agency warned that “risks remain that inflationary pressures could prove more persistent, particularly given a negative real policy rate, which could prompt a higher degree of tightening by the SBP.”

Be that as it may, what is baffling in Pakistan’s case is that when the Prime Minister began to take notice of the inflationary spiral post-IMF agreement in 2019 the SBP laid the bulk of the blame on supply side issues that fed into the Prime Minister’s pet peeve of blaming the mafia (read collusive practices by productive groups operating even in those sectors/subsectors like sugar, cement, etc., that in other countries cannot collude as the number of buyers and sellers is simply too large as well as the retailers/wholesalers windfall profits).

SBP Monetary Policy Committee headed by Governor SBP would no doubt defend the decision to raise the discount rate by pointing out that the Khan administration faced the highest current account deficit in the country’s history – 20 billion dollars. This claim needs to be revised as the July-April 2019 current account deficit was no longer 20 billion dollars but had come down to 11.58 billion dollars before the appointment of the Baqir/Sheikh due mainly to significant inflows from friendly countries – Saudi Arabia, the UAE and China – inflows that the new team leaders pledged to sustain during the thirty nine month IMF programme duration – a pledge that did not have the wherewithal to fulfill. In this context it is relevant to note that after Saudi withdrawal of its 3 billion dollar balance of payment support China met the shortfall without which the Fund programme would have floundered.

Does a large external debt justify a high discount rate? Turkey’s net foreign debt was 268 billion dollars as of 31 December 2020 - 37.5 percent of Turkey’s GDP - against Pakistan’s 119 billion dollars today - more than 87 percent of our GDP in 2020. So there is clearly a serious debt issue in Pakistan. Sheikh however justified his borrowing spree (domestic and external) by focusing the Prime Minister’s attention on the primary surplus (minus borrowing costs). And inexplicably to reduce the debt burden on the budget the Baqir/Sheikh-led team proceeded to convert short term debt into long term debt, a not out of the box solution, but with a discount rate of 13.25 percent actual borrowing costs rose significantly.

The Turkish lira, as aforesaid, fell massively and has lost more than half its value in the last three years as Erdogan fired three governors of the central bank with foreign exchange reserves plunging as the central bank sold 128 billion dollars to stabilise the lira (a policy reminiscent of Ishaq Dar). Today Turkey’s discount rate is 19 percent and Fitch warned that “rebuilding policy credibility will take time and is subject to implementation risks and dependent on the continuation of a tight monetary policy.” Fitch’s warning was outdated as on 1 June 2021 Erdogan publicly commented: “I spoke to the central bank governor today – we certainly need to lower interest rates.” The lira weakened by 4.4 percent that day.

In Pakistan, the rupee has lost around 35 percent of its value since May 2019 but here the economic dynamics are different to Turkey. First, the rupee was seen as under-valued during 2019 and 2020 (with the SBP yet to undertake research to determine its real value by arguing that it is a long-term exercise though exactly how long has never been mentioned) and only in recent months is it perceived to be slightly over valued. Sadly the linkage between an undervalued rupee and higher exports is not confirmed in Pakistan, unlike in Turkey, and hence the rupee erosion simply made imports more expensive and while it did contribute to containing imports yet it also made imports of raw materials and semi-finished products too costly thereby plunging domestic productivity and raising unemployment levels.

To conclude, it is unclear how long the easing of the monetary policy due to the pandemic would be sustainable and of critical importance is how long would the IMF defer the mandatory quarterly reviews with an entire set of time bound quantitative conditions and structural benchmarks while giving the opportunity to the Shaukat Tarin-led Finance Ministry to meet targets through revisiting the conditions agreed by the Baqir/Sheikh team in February 2021.

Copyright Business Recorder, 2021

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