Policy rate hike

EDITORIAL: The Monetary Policy Committee (MPC) raised on 14 December 2021 the interest rate by 100 basis points after 25 days - to 9.75 percent from 8.75 percent announced on 19 November 2021 - making the cost of borrowing in Pakistan the highest in the region with India’s rate at 4.65 percent, Bangladesh’s 4.75 percent and Sri Lanka’s 5 percent. This would raise borrowing costs of large-scale manufacturing sector making them uncompetitive within the regional context; additionally, as the government is the largest borrower in the market, a higher discount rate would imply a significant rise in the mark-up component of the budget (with some economists projecting it at more than 500 billion rupees) with serious implications on the budget deficit, a highly inflationary policy. In this context, it is relevant to note that Pakistan has suffered from unsustainable budget deficits for the past three years (over 7 percent) and the budgeted deficit of 6.3 percent for the current fiscal year is therefore no longer achievable.

The Monetary Policy Statement (MPS) notes that “while some activity indicators are moderating on a sequential basis partly as a result of recent policy actions to restrain domestic demand, growth this fiscal year is expected to be close to the upper end of the forecast range of 4-5 percent. This projection factors in the expected impact of today’s interest rate decision.” The argument is thus that as borrowing costs rise growth would accelerate — a statement at odds with basic economic logic and, of more serious concern, at variance with the 19 November 2021 MPS which plausibly argued that “looking ahead, rising input costs and normalization of macroeconomic policies are likely to lead to some moderation in the growth of industrial activity. Nevertheless, this could be more than offset by the improved outlook for agriculture, such that risks to the growth forecast of 4-5 percent in FY22 are tilted to the upside” — an improved agricultural outlook not backed by recent projections.

The MPS further notes that the reason for the rate rise is to “counter inflationary pressures and ensure that growth remains sustainable”, adding even more inexplicably that “recent data releases confirm that the emphasis of monetary policy on moderating inflation and the current account deficit remains appropriate” — baffling because the rate of inflation rose to 11.5 percent in November (from 9.2 percent in October) with core inflation at 7.6 percent (urban) against 6.7 percent in October; and the current account deficit consistently rose each month in the current fiscal year — from 4.1 percent of GDP in September to 4.7 percent in October (the November data is not yet released however an independent projection is that it may be around 5 percent). It is important to note that a component of the current account, notably trade deficit, has ballooned to 20.5 billion dollars (July-November 2021) and at this rate is likely to rise to over 40 billion dollars by the end of the year – around 10 billion dollars more than the unsustainable 30 billion dollars inherited by this government that led to implementation of severely contractionary monetary and fiscal policies accounting for a contraction of GDP through anti-poor policies.

Three obvious justifications for the rate rise must be noted. First, the MPS notes that “it felt that the end goal of mildly positive real interest rates on a forward looking basis was now close to being achieved.” True enough, but core inflation registered at 7.6 percent (urban) and 8.2 percent (rural) in November 2021 — above the November discount rate of 8.75 percent. Secondly, and perhaps more relevantly as the country is on an International Monetary Fund programme there is intense speculation that the rate rise was a “prior” sixth review condition. This was vehemently denied by adviser to PM on finance and revenue Shaukat Tarin on a private television channel wherein he clarified that all “prior” conditions related to the federal government, including the 330 billion rupee exemption withdrawals, the 4 rupee rise in petroleum levy per month till the upper limit of 30 rupees per litre is achieved, and the passage of the State Bank of Pakistan autonomy bill. If this is indeed correct, the decision to raise the discount rate by 100 basis points at the present moment while continuing to support the government’s cheap credit policy to target groups (small and medium enterprises and farmers) needs to be questioned.

Thirdly, even though the central bank does not engage in inflation targeting, a responsibility that it must take if and when its autonomy bill is passed by parliament - under consideration for an unspecified future date as per the IMF press release after the sixth review agreement was reached - yet it can and does mop up rising domestic demand which is fuelling inflation but ignored is the fact that the rise in domestic demand post-pandemic lockdown, a global phenomenon, was fuelling growth.

This newspaper acknowledges the extremely trying prevailing global and domestic economic conditions; however, it is relevant to cite a statement by Sri Lankan central bank on 25 November 2021 while maintaining the standing deposit facility at 5 percent and the standing lending facility rate at 6 percent: “The Board noted the recent acceleration of inflation, driven mainly by supply disruptions and the surge in global commodity prices, and reiterated its commitment to maintaining inflation at the targeted levels over the medium-term with appropriate measures, while supporting the economy to reach its potential in the period ahead.”

Pakistan’s challenges are much more serious than those of Sri Lanka’s; however, the monetary policy needs to be more in tune with the government’s stated objectives and the objectives of other central banks grappling with pandemic aftershocks: a rising budget deficit, a sustained rupee erosion and last but not least heavy reliance (more than 50 percent) on borrowing to shore up the foreign exchange reserves.

Copyright Business Recorder, 2021