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KARACHI: The Policy Advisory Board – Federation of Pakistan Chambers of Commerce and Industry (FPCCI) has recommended that the State Bank of Pakistan (SBP) must target core inflation rather than general inflation, as the core inflation is a better measure of demand-pull inflation.

The FPCCI Policy Advisory Board in its research paper entitled “Assessment of Monetary Policy Effectiveness in Pakistani” said the inflationary pressure due to reforms under the International Monetary Fund (IMF) program must not be controlled by raising policy rates. It suggested that market-based flexible exchange rate regime should be replaced with managed-float regime in order to avoid imported inflation. Government should use prudential regulations to curb demand pulls more effectively. The paper said the monetary policy measures have differential impacts on different industries and income classes. Impact on the spectrum of industries and income classes must be evaluated before formulating policies. Authorities must urge IMF to allow government borrowing from the central bank. Government’s alternative reliance on commercial banks would end up borrowing expensive loans along with crowding-out effect on private borrowing.

Recent Monetary Policy Measures: The SBP tightened the auto loans and personal loans financing by revising prudential regulations for consumer financing. Similarly, it has increased the average cash reserve requirement from 5 to 6 percent and the minimum requirement from 3 to 4 percent. Such monetary policy measures are more focused and would help arrest demand-induced inflation. Raising interest rates across the board is unlikely to yield the desired results.

Positive Relationship between Policy Rates and Inflation: There exists a strong and positive relation of policy rates with both general and core inflation during Jan-20 to Nov-21 that is 0.61 and 0.66, respectively. This is in contradiction to the SBP’s objective to contain inflation by raising policy rates.

Resumption of IMF Program and Inflationary Pressure: In a bid to resume the Extended Fund Facility (EFF) Program of International Monetary Fund (IMF), the federal government is set to increase the petroleum development levy by Rs. 4.0 per month until it reaches the maximum levy of Rs. 30. In addition, National Electric Power Regulatory Authority (NEPRA) is likely to increase the electricity price up to Rs. 4.75. Both these measures along with others will trigger inflation further and tackling such inflationary pressure by raising policy rates would further aggravate the inflation and push the economy into stagflation.

Surge in Imports due to Price Change: The surge in imports of petroleum and food groups is mainly due to the global market prices. During Jul-Oct 2021, imports of selected food and petroleum products were US$ 2.74 billion for which import value of around US$ 2.66 billion is due to the price change whereas volume change in imports of aforesaid products accounted for US$ 0.08 billion only. Inelastic import demand and inflationary pressure due to these reasons are unlikely to be controlled through raising policy rates.

Limited Credit to Private Sector: According to the World Bank Enterprise Survey, only 7 percent of firms in Pakistan raise finance from formal credit lending institutions. Credit to the private sector (as a % of GDP) for Pakistan was 17.1% in 2020 which is the lowest among the regional peers. Moreover, around 10 percent of outstanding loans to the private sector by the end of October 2021 were covered under SBP’s designated fixed rate schemes. It reflects a very weak formal credit lending channel exists between industry and financial institutions. Therefore, raising the cost of borrowing to curb demand is very unlikely to yield desired results.

General versus Core Inflation: The general inflation measured by consumer price inflation on a year-on-year (YoY) basis has been increasing since August 2021 and has reached 11.5 percent in November 2021. The core inflation on a year-on-year basis for October and November 2021 were 6.7 percent and 7.6 percent, respectively. Since the reasons for high inflation are commodity prices and fuel imports, the SBP must target core inflation only.

Monetary Policy Survey Results: Monetary policy survey reveals that around 58 percent of the overall respondents oppose increasing the policy rate further. In addition, the prevailing market-based flexible exchange rate regime is rejected by the majority of the participants, i.e., around 58 percent. However, inflation is expected to rise further as anticipated by a significant majority, i.e., 83 percent.

Pakistan’s policy rate in excess of core inflation is higher than India and China. Pakistan’s current policy rate is 8.75 percent which is well above the regional peers. China, India, and Bangladesh have maintained their policy rates at 2.0 percent, 4.0 percent, and 4.8 percent, respectively.

Business and Consumer Confidence: A dramatic decline in business and consumer confidence indices since July 2021 indicates poor economic sentiments among industry participants and consumers. Moreover, large-scale manufacturing contracted by 0.7 percent in September 2021.

Inflation Expectation: Measures under the IMF program, exchange rate, global market prices, international commodity prices, and other supply-side distortions are expected to trigger inflation in the near term. However, inflation due to supply-side factors must not be controlled by increasing policy rates.

Business Cycle Positioning: Pakistan is currently undergoing a recessionary phase of the business cycle since 2016 and is expected to continue in recession till FY 2023. Business cycle theories contend that expansionary monetary and fiscal policies should be adopted to boost economic activity. On the contrary, the State Bank of Pakistan raised the policy rate in the last two consequent monetary policy meetings held in September 2021 and November 2021. Unlike other monetary policy tools, raising policy rates fuel cost-push inflation, deteriorate the fiscal equation, and widen the income inequality besides mitigating aggregate demand.

The Board proposes that the SBP should keep the policy rate unchanged in the upcoming monetary policy committee to help revive the economy.

In addition, it is recommended to target core inflation rather than general inflation. Given the moderate economic outlook with the decline in real sector and deterioration in business confidence, it is imperative for the SBP to not control supply shock induced general inflation by raising policy rates.

Pakistan is heading towards stagflation with inflation mounted to 11.5 percent in November whereas visible deterioration in key economic indicators has been evident.

The core inflation was recorded at 7.6 percent in November 2021, up by 0.9 percentage points. The SBP has increased the policy rate by 25 and 150 basis points in the last two monetary policy committee meetings, which has raised cut-off yields by 228 basis points for three-month T-bills to 10.78 percent. It is imperative to note here that supply shocks such as a hike in commodity and oil prices provided the impetus for current inflationary pressure.

In addition, massive depreciation of the Pakistani rupee against the US dollar along with measures under IMF Program has further triggered inflation.

Copyright Business Recorder, 2022


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