EDITORIAL: The Monetary Policy Committee (MPC) decided to raise the discount rate by 25 basis points –- from 7 to 7.25 percent — in line with market expectation of between 25 to 50 basis points which is considered not significant enough to act as a dampener on borrowing by the private sector, the engine of growth. This decision as per the MPC is “still appropriately supportive of growth,” an overarching objective of Finance Minister Shaukat Tarin, while adding that real interest rates remain negative on a forward looking basis – a claim substantiated by the fact that inflation in July and August 2021 was cited as 8.4 percent, Consumer Price Index which previous to May 2019 was not used to determine the discount rate, while the discount rate is 7.25 percent.
Some independent economists cite the pending sixth review talks by the end of this month with the International Monetary Fund (IMF) as a possible trigger to raising the rate as public angst against the depreciating rupee - from 153 rupees end-May 2021 to over 168 rupees today or around 10 percent depreciation in a little less than four months - may have prompted the State Bank of Pakistan (SBP) Deputy Governor to issue a warning to currency speculators on a private television channel less than a week ago that “we at State Bank are watching the developments very closely and we believe that there are some fundamental factors for the depreciation of the rupee…our trade deficit has increased because the economic growth in the country is picking up, and along with that, international commodity prices are rising, impacting the import bill, and then if some people start speculating, they must remember that they will be the losers at the end of the day.”
The MPS noted that “the SBP does not suppress an underlying trend in the exchange rate and any interventions are limited to address disorderly market conditions.” Critics point out that disorderly market conditions have prevailed since May 2021 with volatility in the domestic market sourced to a rise in aggregate domestic demand for consumer items, particularly cars and cement, on the back of industry-specific monetary and fiscal incentives extended to deal with the aftermath of Covid-19 — conditions that have exacerbated subsequent to the fall of Kabul to the Taliban. It is, however, important to note that the decision to allow the rupee to fall is supported because it eased pressure to raise the discount rate to mop up aggregate demand which would have had serious negative implications on productivity irrespective of the fact that the real effective exchange rate (REER) as determined by the SBP for August 2021 was 97.3 against 99.8 the month before – a decline that perhaps indicates that the rupee is undervalued due to the prevailing disorderly market conditions.
The MPS further claims that “since the rupee was floated SBP’s gross foreign exchange reserves have nearly tripled to a record 20 billion dollars, while net international reserves have risen by nearly 16 billion dollars between end-June 2019 and end-August 2021…while the flexible exchange rate has appropriately played its role as a shock absorber it is important that its role be complemented by strong exports, targeted measures to curb non-essential imports and appropriate macroeconomic policy settings to contain import growth.” While one would have hoped for the review period to encompass the PTI government’s entire tenure instead of being limited to the period under the IMF programme, yet three observations are necessary: (i) the rupee is not in a free float as perhaps implied, for example, the dollar, Euro or Pound but is market-based defined by the IMF as when the “monetary authority attempts to influence the exchange rate without having a specific exchange rate path or target. Indicators for managing the rate are broadly judgemental (e.g. balance of payments position, international reserves, parallel market developments), and adjustments may not be automatic. Intervention may be direct or indirect;” (ii) the rupee rate did little to attract reserves which remain largely debt-based — swap arrangements of over 4 billion dollars, debt equity (sukuk/Eurobonds) issued at rates well above the global rates and close to the discount rate prevalent in Pakistan, and borrowing at a high rate with low amortization period from commercial banks abroad; and (iii) the rupee fall has fuelled inflation. The MPS rightly argues that inflation outlook ahead depends on the path of domestic demand, and administered prices, notably fuel and electricity, as well as global commodity prices. But equally relevant is to reverse the existing trend of massive reliance on domestic and expensive external borrowing which is also contributing to spiraling domestic prices.
The MPC regards the 7.25 percent discount rate as accommodative but adds that with possible further gradual tapering of the stimulus it may achieve mildly positive real interest rates which ideally may be achieved through a containment of inflation. The Statement clearly shows that the MPC had deeply reflected upon all the different parts and effects of the situation in order to arrive at an informed decision.
Copyright Business Recorder, 2021
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