Dr Reza Baqir, Governor State Bank of Pakistan (SBP), during his interview to Bloomberg on 17 December stated that the apex bank would “pause” interest rate hikes to preserve economic recovery after delivering Asia’s boldest hikes since September 2021.
This statement was made just three days after the Monetary Policy Committee (MPC) decision to raise the discount rate by 100 basis points to 9.75 percent on 14 December - a rise subsequent to the 150 basis point rise 25 days previously on 19 November and 25 basis point on 20 September 2021.
The question that begs an answer is whether the decision to raise rates at the present time was bold or its exact opposite timid as a growing number of critics of SBP monetary policy decisions maintain that the decision to raise rates further was an International Monetary Fund (IMF) prior condition of the sixth review.
This has been publicly and vehemently denied by the de facto Finance Minister Shaukat Tarin – a man who had severely criticized the decision of the SBP to set the discount rate at 13.25 percent in 2019 (July-March) – even higher than the Consumer Price Index (CPI) of around 12 percent for the year (though the IMF had projected the inflation rate at 13 percent for the year) instead of linking the rate to core inflation of less than 7 percent as in the past (comprising of non-food non-energy items and therefore more responsive to rate changes).
Tarin’s support for the recent rate rise is premised on the fact that it is in synch with the rise in November’s core inflation - 7.2 percent (urban) against 6.7 percent in October and 8.2 percent (rural) against 6.7 percent in October. Ignored is the fact that even with the rise in core inflation the 19 November discount rate of 8.75 percent was around 2 percentage points higher than core inflation (urban) which has widened to 2.5 percent after the rate rise of 14 December.
Ironically the Monetary Policy Statement of 14 December noted that “the Monetary Policy Committee felt that the end goal of mildly positive real interest rates on a forward looking basis was now close to being achieved.”
This claim is inexplicable unless of course the MPC continues to link the discount rate to CPI, a practice one had hoped had been abandoned after its disastrous results July-2019 to March 2022 (pre-pandemic).
So what or who would be most affected by the recent rate rises of 275 basis points since September this year? First, the government as the largest single borrower from the market will witness a rise in its budgeted mark-up payments (budgeted at an alarming 40 percent of total current expenditure, which includes the Prime Minister’s signature Ehsaas programme, for the current year).
According to one estimate, the rise could well be above 500 billion rupees. If this rise is seen in the context of the prior condition of withdrawal of 330 billion rupee exemptions through a money bill - envisaging mainly sales tax exemptions as per a Business Recorder report not denied by the Federal Board of Revenue - an indirect tax whose incidence on the poor is much greater than on the rich - one would have to distressingly conclude that the “boldest” rate hike in Asia may well lead to the money bill that has yet to be tabled in parliament as a first in the current year.
Secondly, the large scale manufacturing (LSM) sector, another major borrower in the market, would experience a hike in its cost of borrowing (an input cost) that would make it uncompetitive in the international market place (exports) while in the domestic market the cost and therefore the price of their products would rise that may well fuel smuggling given our porous borders which, in turn, would require even greater policing than at present at a higher cost to the economy.
Recent data released by the Pakistan Bureau of Statistics (PBS) indicates that LSM rose by 3.56 percent July-October this year compared to the comparable period of the year before - a major contributor to total industrial output, urban employment as well as accounting for over 10 percent to GDP.
Notwithstanding this positive trend it is relevant to note that LSM in October 2021 decreased by 1.19 percent compared to October 2020 – a trend that maybe exacerbated subsequent to the November and December rate rises. Data for November is yet to be uploaded on the PBS website however the impact of the rate rise would be in addition to the contribution of the ongoing gas shortages experienced by several major industries.
The growing number of critics of SBP policy in recent years continues to maintain that the rate rise is due to IMF prior condition in spite of the denial by Tarin for two reasons. First, it is standard normal Fund policy (also evident in its most recent Egypt programme), followed by SBP in 2019, to raise the discount rate as a means to attract “hot” money which is as easy to enter the market as it is to exit the market – a fact that Pakistan learned to its cost in March/April 2020.
Second, while Pakistan’s inflation rate is the highest in Asia, with a discount rate rise normally used to mop up excess liquidity, yet excess liquidity is unlikely to be mopped up by a rise in discount rate for four reasons: (i) the government is not reducing the budgeted rise in current expenditure in the ongoing year compared to the year before, a major source of inflation, and instead, contrary to the rationale provided in economic theory, is raising current expenditure through its economically flawed decision to subsidize prices of essential items and expansion of the Ehsaas programme. In other words, it is disbursing a larger cash amount to each beneficiary on the one hand and eroding the value of each rupee it is disbursing at a faster pace on the other hand; (ii) SBP has no inflation targeting policy, the IMF stated in its press release subsequent to the completion of the sixth review talks that at some future point the Bank would begin inflation targeting; however, as noted above, in the 14 December MPS the rise in the discount rate may have been tacitly agreed with the Fund staff with the objective of achieving positive real interest rates.
In economic theory positive real rates of interest attract higher investment inflows however in Pakistan, with inefficient state run utility sectors, a tax structure that is unfair, inequitable and anomalous and serious security issues, a rate rise attracts foreign portfolio investment (hot money) and not foreign direct investment and instead discourages local production; (iii) the agreement with the IMF envisages a rise in administered prices with the objective of achieving full cost recovery however like previous administrations the incumbent government has shown no aptitude to improving performance of entities operating under its management and has instead relied on raising rates for end consumers; and (iv) the mafias (manufacturers/wholesalers/retailers) as defined by the Prime Minister continue to flourish and their contribution to inflation remains.
To conclude, what is clear is that the rise in discount rate has not contained inflation and therefore perhaps the need is not to look at conventional economic theory or IMF standard prescriptions but at our domestic linkages, or lack thereof, prior to taking decisions with far-reaching implications on the quality of life of the general public.
Copyright Business Recorder, 2021