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EDITORIAL: Rating agency Fitch’s projection that interest rate hike will continue in frontier markets facing external pressures such as Pakistan comes as no surprise. A State Bank of Pakistan’s (SBP’s) press release dated 19 November noted that “in continuation of efforts to make the process of monetary policy formulation more predictable and transparent in line with international best practices, the SBP has decided to increase the frequency of monetary policy reviews from six to eight times a year”, which fuelled speculation that interest rates would be raised in the Monetary Policy Committee (MPC) meeting scheduled for 14 December.

Under the amended Reserve Bank of India Act, the Monetary Policy Committee (MPC) is required to meet at least four times a year, in Bangladesh once every month or at least once every quarter, and the US federal open market committee holds eight regularly scheduled meetings during the year and other meetings as needed. The key words in holding more frequent MPC meetings must be ‘as needed’ and to claim that the process of monetary policy formulation would be more predictable and transparent in line with international best practices simply by adding on two more meetings a year is inexplicable.

The market perception that interest rates will be raised is rooted in the recent successful conclusion of the sixth staff review with the International Monetary Fund (IMF) premised on the implementation of a host of “prior” conditions that include a raise in the discount rate. While the Advisor to the Prime Minister on Finance and Revenue Shaukat Tarin has publicly acknowledged that ‘prior’ conditions or actions include withdrawal of 330 billion rupee exemptions to be implemented through the passage of a money bill and not an ordinance, petroleum levy to be raised by 4 rupees per month till it reaches the maximum limit of 30 rupees per litre and base electricity tariffs will be raised the SBP has understandably been more reticent in highlighting what it has agreed to as prior conditions.

Notwithstanding this reticence, past precedence indicates that unlike the Ministry of Finance, the SBP invariably meets all the agreed conditions – prior as well as programme conditions – even at the cost of considerable public criticism. In this context, the cost of borrowing in Pakistan is almost double the regional average, a factor that compromises the capacity of productive sectors to compete internationally. And as the government is the largest borrower – its domestic debt has risen from 16.5 trillion rupees three years ago to over 26 trillion rupees today – any rise in the discount rate raises its cost of borrowing, thereby raising the mark-up component of the budget with a consequent impact on the deficit. The fact that the bulk of this borrowed money is injected back into economy and that too as current expenditure which has risen from 3.9 trillion rupees in 2017-18 to 7.5 trillion rupees today, it is little wonder that inflation is so high.

The rupee has also been allowed to erode and measures to check its decline, including borrowing 4.2 billion dollars from Saudi Arabia for one year at 4 percent, have so far not been successful. The SBP justifies the rupee erosion by noting that the rupee remains undervalued as the real effective exchange rate (REER) for September 2021 was at 95.8, down from the previous month’s 96.5, (conveniently data for October and November has yet to be calculated or uploaded). This is supported by the IMF press release dated 21 November at the conclusion of the sixth review wherein it unambiguously stated that the SBP must remain focused on curbing inflation (which a higher discount rate is unlikely to achieve as noted above), preserving exchange rate flexibility (which is fuelling domestic inflation at a rate higher than the regional average as well as amongst our trading partners), and strengthening international reserves (sadly mainly through borrowing).

And, ironically, the Fund statement does not specify the time period inflation targeting regime is to be implemented: “As economic stability becomes entrenched and the independence of the SBP is strengthened with the approval of the SBP Act Amendments, the central bank should gradually advance the preparatory work to formally adopt an inflation targeting (IT) regime in the medium term, underpinned by a forward-looking and interest-rate-focused operational framework.”

Pakistan is on a Fund programme with no predetermined path for the exchange rate and no inflation targeting framework. Had inflation targeting been its objective there would have been, as per the Fund, “public announcement of medium-term numerical targets for inflation with an institutional commitment by the monetary authority to achieve these targets. Additional key features include increased communication with the public and the markets about the plans and objectives of monetary policymakers and increased accountability of the central bank for attaining its inflation objectives. Monetary policy decisions are guided by the deviation of forecasts of future inflation from the announced target, with the inflation forecast acting (implicitly or explicitly) as the intermediate target of monetary policy.”

A comparison with other regional countries reveals that India, not on a Fund programme, has no explicitly stated nominal anchor, but monitors various indicators in conducting monetary policy. Bangladesh and Sri Lanka have a monetary aggregate target, and Nepal has a fixed rate arrangement. Last but not least, the central bank is required to seriously examine the question whether or not any further hike in the current interest rate will make the probability of arrival of stagflation even greater.

Copyright Business Recorder, 2021

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