State Bank of Pakistan (SBP) is its latest monetary policy statement (MPS) increased policy rate by 150 basis points to 8.75 per cent, stating, among other things, that ‘risks related to inflation and the balance of payments have increased.’ This tight monetary policy stance was also supported by the International Monetary Fund (IMF) in its recent statement on Pakistan. According to it, ‘the State Bank of Pakistan (SBP) has also taken the right steps by starting to reverse the accommodative monetary policy stance….’
Inflation is mainly due to higher commodity prices and so is the resultant impact of widening of current account deficit due to higher import payments. While trimming of list of imports has some room in terms of curtailment, on the other hand, tightening of monetary policy stance is likely to produce little impact in terms of reducing inflation through aggregate demand curtailment since most inflation strongly appears to be a supply-shock induced phenomenon, and is quite inelastic in nature given large imports of oil and food commodities.
Therefore, a policy rate hike is not likely to affect much in terms of curtailing or containing inflation mainly because of the fact that in developing countries like Pakistan inflation is a fiscal phenomenon. On the other hand, higher policy rate is likely to increase the already debt repayment obligations. Given the policy rate hike, the government will find it extremely difficult to keep repayments on its ambitious housing scheme payments under a ceiling as it will be facing a higher budgetary support burden of providing a possible subsidy in due course to manage rising interest rate pressures on that ceiling.
The government can face a similar situation in terms of possible greater subsidy demands, requiring it to keep interest rates low on subsidized loans for youth under ‘Kamyab Jawan Programme’, and other ‘Ehsaas’ loan schemes. With the IMF already looking at government to reduce primary deficit—as it highlighted in the same statement that ‘In addition, the government plans to introduce a package of fiscal measures targeting a small reduction of the primary deficit with respect to last fiscal year…’—means that the government will find it difficult to provide the stimulus spending the economy needs to grow out of the recessionary impact of Covid over a number of months during last fiscal year, and in pushing back the rising costs of doing business given higher costs under supply-chain shocks.
The government has already shown signs of reducing stimulus spending by reportedly planning to take back a number of tax concessions. This appears quite strange that while the rich, advanced countries have provided significant stimulus to their economies, developing countries with greater stimulus needs mainly because of slower economic recovery than the global north primarily due to vaccine inequality phenomenon and higher impact in terms of imported inflation given low per capita income are not providing any significant stimulus under tighter macroeconomic policy stance that it is moving towards, both through domestic policy, and also under the IMF programme conditionalities/priorities.
Yet, the SBP is clearly not seem to be putting a lot of weight on these repercussions from raising policy rate on possibly subduing economic recovery and poverty reduction efforts. Not only is SBP expecting that policy rate rise will likely produce a meaningful impact in terms of reducing inflation and current account deficit, it is also hoping that such a rise will also help bring greater foreign exchange reserve build-up through greater portfolio investment. The SBP governor, Dr Reza Baqir, was quoted in a recent Financial Times (FT) article ‘Pakistan’s central bank chief warns of taper-tantrum style shock to emerging markets’ as saying: “This will disproportionately hurt developing countries if foreign investors end up dumping emerging and frontier market assets owing to unexpected interest rate rises in advanced economies.” According to him, “If there’s volatility in financial markets because there is a somewhat sudden realignment of expectations of interest rate changes in advanced economies, that volatilitywill impact emerging markets with high debt and moderate or low levels of reserves more than otherwise.”
This is clearly unfortunate to see that policymakers are continuing with the traditional thinking in the country of looking to boost reserves through making portfolio investment attractive, and remaining worried about retaining it, and not realizing the high cost of pursuing this rather fickle and highly fluid source of building reserves. Moreover, as indicated, tighter monetary policy stance, and its spillover push in terms of a tighter fiscal policy stance, has a much greater growth sacrifice and a weak reducing impact in terms of inflation and current account deficit than the transitory gains in terms of reserves build-up.
Developing countries need greater financial support from treasuries of rich countries, and multilateral institutions like the IMF and World Bank since tightening of monetary policy is only going to risk a debt pandemic and higher poverty, and in turn lesser capacity for quicker economic recovery and higher domestic resources mobilization that such a recovery brings. In the particular case of Pakistan, the current macroeconomic policy stance, if anything, should be eased even if it means foregoing the hurdles of an IMF programme. The costs of the programme are much higher than the benefits of such tight policy stance that it may bring. The government should revisit its macroeconomic policy stance with a more clear-headedness, and should look to have greater bearing on both monetary and fiscal policies, since after all these are difficult times for economy and democracy, and government is primarily answerable to the masses. Moreover, the government should look to play a greater role in terms of economic diplomacy to indicate to the world not only the limitedness of macroeconomic policy instruments in the hands of developing countries in the wake of the longevity of the pandemic, higher commodity prices and supply-chain shock that they have to face but also the importance of greater financial support that they need more than anything to provide needed stimulus for economic recovery, and in avoiding a balance of payments-debt crisis.
(The writer holds a PhD in Economics from the University of Barcelona; he previously worked at the International Monetary Fund)
Copyright Business Recorder, 2021