No change as expected. The markets took forward guidance with a surprise. SBP has shown clear indications of not moving towards mildly positive rates. The writing is that the current real rates on forward looking are appropriate for medium-term inflation outlook of 5-7 percent. SBP is not seeing any reason to tighten further to counter expected double-digit inflation in the next few months. The reliance of cutting energy price led import bill is expected through fiscal policy tools. The demand tapering is visible from flattening LSM growth.
The impact of 275 bps increase in the policy rate in the last four months is starting to appear, and that has changed the tone of SBP to be accommodative. SBP has more information than the market. It seems that there are signs of import easing in three weeks of January. The key number to watch in Pakistan is the current account and broad macro stability in the external account. If SBP appears to be comfortable on it, the rest of all variables will start falling in place.
The problem is that the market was smelling blood. They saw 13.25 percent policy rate to tackle 9-11 percent inflation in FY20 and expecting similar rates to tackle 9-11 percent inflation in FY22. A few are betting to get bonds at 13 percent. What they miss is that the inertia of three years demand-led current account deficit, in days when many commodity prices were at decades low, would take time and stern actions to unwind.
Today the case is different. One year of demand-pull is well-handled through 275 bps hike in policy rate and around 15 percent currency depreciation – both these were missed during 2016-18. Demand was unleased. The timely leash this time has put things in place. The numbers are already showing signs of tapering off. And the current account is expected to ease in 2HFY22. That should be enough to put markets on the right path.
Just to give perspective, non-oil current account deficit was $6.5 billion in FY18 and is expected to be in surplus in FY22 ($0.7 bn in 1HFY22). Then the quality (low forward/swap liabilities) and quantity of reserves in 2019 was poorer than 2022. All these factors are part of the policy decision. The dynamics cannot be simply seen for the lens of inflation in an economy like Pakistan.
The market bulls could argue that still oil is a big animal—how can SBP ignore its impact on current account and inflation? Well, oil-related imports tapering could be quick and effective through fiscal policy. One must not forget that today’s current account slippage could be related to 2008, not 2018- as back then commodity prices led to the crisis. The mistake the then federal government made was not to pass on the impact of increase in oil prices to consumers. Here the IMF programme is present to ensure certain fiscal discipline. Then SBP is also relying on other fiscal contractionary measures – such as reduction in development budget and tax measures in the mini budget.
Nonetheless, SBP has dealt with a rough hand. The nascent economic stability is challenged by almost all the commodities simultaneously at their multi-year high. The outlook in the near term is not good. The key is the right mix of fiscal and monetary policies which IMF is ensuring.
The question is whether the markets adjust to SBP’s changing stance. The forward guidance was questioned a few months back and SBP is bold enough to give another sharp shift. The market may take time to adjust. The fiscal side is to tag along with the SBP. In the upcoming T-Bills and PIBs auctions, the treasury office in ministry of finance must sync with SBP’s signal in terms of cut-offs signals. They both must work together on taming market exuberance. P.S: Higher the oil prices go, harder will be to control the market rush of blood.