The monetary policy committee meeting is on coming Monday (20th Sep). One can sense the change in the air. But the political pressures still mount, and status-quo cannot be ruled out. The two probable options are – no change and 25 bps increase. Informal surveys with a few economists and market players suggest the same. Another survey by Topline Research shows nearly two-third of the participants expecting no change, while a fourth expect a 25 bps increase.
There are clear pressures of imports slipping current account deficit and depreciating PKR against falling USD (against other currencies). Islamabad is propagating high growth while hawks in SBP are flexing muscles. Fin-min might be pressing to do nothing. Then the other side has a reasonable argument to give demand control signal. The debate is likely to take place in the MPC meeting on Monday, and the message to MPC members is better to be proactive than reactive.
In a way monetary management is more of an art than science. Signaling matters, especially in an economy that is transiting into a market-based exchange rate regime. There is a trade-off between exchange rate and interest rates. If interest rates are kept low in days of higher imports demand, exchange rate must depreciate more. If the policy is to continue with negative real rates and let the exchange rate slip further, there could be a case of higher tightening next year to counter inflationary consequences of depreciation. The other option is to act today by moderating the inflationary pressures by giving the right signal to the market.
The proponents of high growth should realize that elections are not round the corner. The current policy rate cannot continue till the elections (even if the elections are called earlier than expected). Keeping the pressure on accelerator paddle, given soaring global commodity prices, the external account led crisis can come prior to elections which could lead to sharp interest rates and current account adjustments– there are enough evidence in the past to say that. It is better to moderate today and keep the ammunition for the next year.
Contrary to general perception, IMF might not be pushing for the rate hike. IMF has three issues – one is central bank independence. The other two are on fiscal revenues and energy pricing. The way currency is moving, IMF must be content with SBP’s independence. Then imports led growth is making FBR a shining star – tax revenues are doing better than expectations. The bone of contention with the IMF is energy pricing – power tariffs, gas prices and petroleum prices. All of them (especially gas and petroleum) should increase.
However, SBP should think on not letting the bubble to build. The key concern is imports – two out of last three months have imports (PBS) higher than $6 billion. The one-offs are becoming sticky – like wheat imports. Then there are one-offs for the full year – TERF and COVID vaccine, related imports. These two would have monthly impact of $300-350 million for this fiscal year. Then the international commodity prices are at multi-years high. This is adding to the import pressure, especially when the impact of increase in international prices is not fully reflected in domestic.
For example, the international oil prices (Brent) went up by 73 percent from October20 to Aug21, while the domestic petrol prices are up by mere 13 percent. Similar is the story of LNG. Even private sector players are discouraged to increase prices. For example, cement players are pushed to not increase price owing to rising coal prices. While the steel prices impact on autos are diluted by lowering duties on cars.
The point is that there is no demand check due to increase in international commodity prices, but the import bill keeps on rising. This is putting pressure on currency and eventually the price impact is to be translated - else there will be shortage of cement, cars, and other products. Either way, demand will be checked eventually. But the currency shock could be bigger on larger economy. That is why it is better to check demand through other measures.
Some argue that 25 bps increase is neither here nor there. Yes, there is no doubt on it. As mentioned above, the hike recommendations are for signaling. To curtail demand, Islamabad must act. The energy pricing needs to be rationalized. This has both fiscal and external account implication. 2008 crisis was mainly due to mismatch in domestic petroleum and international oil prices. Do not repeat it. Do not fiddle with international prices. If this policy continues, the increase in interest rates tomorrow would be higher.
Some argue that inflation is tapering off. Given no passing of energy prices, and considering high base effect, average inflation in next six months would be 1.5-2 percentage points lower than previous six months. But this way of artificially keeping prices low cannot continue. If Islamabad is too eccentric about price control, SBP must have a balancing act.