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On 20 September 2021 Monetary Policy Committee (MPC) announced its decision to raise the discount rate by 25 basis points - from 7 percent prevalent for more than a year to 7.25 percent. This rise is in line with the pro-growth policy favoured by Finance Minister Shaukat Tarin, so noted the Monetary Policy Statement (MPS), however the question is whether it is in synch with the overarching objective of a central bank: to check inflation.

Three observations are in order. First, the MPC chaired by Governor State Bank of Pakistan (SBP) needs to revisit its continued focus on consumer price index (CPI) - a decision taken since mid 2019. This decision has been consistently criticized by previous governors and independent economists (on condition of anonymity) as CPI consists of items that are not sensitive to discount rate manipulation as per a SBP 2006 study. Core inflation on the other hand consisting of non-food, non-energy items is sensitive to the discount rate and the previous practice was to announce a discount rate that was no more than 1 to 2 percent points higher than core inflation, at best.

With a 7 percent discount rate in July and August 2021 the CPI in the two months was constant at 8.4 percent and core inflation was 6.9 percent in July and 6.3 percent in August. In the current month the discount rate was raised by 25 basis points though CPI was constant in the previous two months and core inflation actually declined last month. Be that as it may, the discount rate remains closer to core rather than CPI however this assertion falls flat when seen in the context of the MPS.

The 20 September 2021 MPS notes: "inflation fell from 9.7 percent (y/y) in June to 8.4 percent in both July and August. In addition to favourable base effects, this decline reflects continued deceleration in administered prices of energy due to the reduction in PDL and sales tax on petroleum products. Core inflation also fell in both urban and rural areas in August." The focus is unambiguously on the CPI and though core inflation is referred to yet, tellingly, its rate is not cited. Supporters of the MPS argue that the accommodative policies of the SBP, like other central banks across the world, were critical in dealing with the aftermath of the pandemic onslaught.

True, however critics maintain with equal veracity that: (i) SBP's policy to provide cheaper credit under its four pandemic related schemes (Rozgar scheme, Temporary Economic Refinance Facility, Loan Extension and Restructuring Package and supporting the Health Sector) presents a challenge to its claim that the 7 percent discount rate reflects an accommodative policy measure; and (ii) the 20 September and 28 May 2021 MPS correctly cite administered prices as inflationary, but these decisions not are within the SBPs domain though demand side pressures are within its domain.

The last two MPS; maintain that demand side pressures continue to be relatively contained - a baffling claim as demand particularly for vehicles and cement due to government policies rose dramatically which incidentally accounts for the 3.94 percent growth rate last year. Passing on the buck is neither fair nor appropriate and the Monthly Economic Update and Outlook August 2021, a publication of the Ministry of Finance, notes more accurately that the responsibility for inflation lies with both Ministry of Finance and SBP policies: "Pakistan's inflation rate is mainly driven by current and past fiscal and monetary policies, international commodity prices, USD exchange rate, seasonal factors and economic agents' expectations concerning the future developments of these indicators."

Sensitive to criticism of the rupee depreciation since May this year, a highly inflationary policy which is within the SBP's ambit, the MPS noted that the exchange rate played its appropriate role. This can and should be challenged on four counts: (i) the rupee float is market based, defined by the IMF as when a "monetary authority attempts to influence the exchange rate without having a specific exchange rate path or target. Indicators for managing the rate are broadly judgmental (e.g. balance of payments position, international reserves, parallel market developments), and adjustments may not be automatic" - or in other words, the judgment exercised by the SBP can and should be challenged; (ii) the rupee depreciation is cited as 4.8 percent in the MPS however since May this year the rupee has depreciated by about 10.4 percent - from 153 rupees end-May 2021 to over 169 rupees today; (iii) the MPS links the rupee erosion with reserves which is surprising as more than 50 percent of the reserves are debt based; and (iv) the real effective exchange rate (REER) uploaded on the SBP website is 97.37 for August down from the July figure of 99.4 - statistics that support the SBP's decision to allow the rupee to depreciate however this also raises questions about the calculation of the REER.

Secondly, the 20 September MPS noted that: "over the last few months the burden of adjusting to the rising current account deficit had fallen primarily on the exchange rate and it was appropriate for other adjustment tools, including interest rates, to also play their due role. The MPC noted that the stance of monetary policy is still appropriately supportive of growth, with real interest rates remaining negative on a forward-looking basis." The current account deficit with a record high remittance inflow of 29 billion dollars last year is not yet a source of concern and this was rightly stated in 28 May 2021 MPS: "The MPC noted that, unlike several previous growth upturns in Pakistan, the current economic recovery has been achieved without compromising external stability....imports have picked up with the economic recovery, rising international commodity prices, as well as one-off shipments of wheat and sugar to quell temporary domestic shortages. However, this is being largely offset by record remittances." One would hope for more consistency in arguments from one MPS to the next.

Finally, the 20 September 2021 MPS notes: "inflation expectations of both households and businesses have drifted up and wage growth has picked up as the recovery has strengthened. Looking ahead, the inflation outlook largely depends on the path of domestic demand and administered prices, notably fuel and electricity, as well as global commodity prices." The reference to wage growth needs to be detailed as data suggests that the growth is not widespread but limited to government employees, paid for by the taxpayers and a raise in the minimum wage.

To conclude, there is a need for those MPC members who are monetary economists to challenge some of the assumptions and decisions taken in recent months/years failing which the government needs to step in through the monetary and fiscal policy coordination policy board to undertake some mitigating measures. Silence on this count simply suggests that the Ministry of Finance and SBP are on the same page.

Copyright Business Recorder, 2021


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