EDITORIAL: An emergent meeting of the Monetary Policy Committee was called on 7 April 2022 and the Monetary Policy Statement (MPS) raised the discount rate by 250 basis points — from 9.75 to 12.25 percent — a raise that few would criticise as the trade deficit had widened to a historic high of 35.39 billion dollars, the foreign exchange reserves had plummeted to 11.3 billion dollars (due to repayment of debt including a syndicated loan facility from China as well as settlement of an arbitration award with Reko Diq, envisaging a 900 million dollar payment to Antofagasta Plc to exit the project against its claim of 3.9 billion dollars), core inflation (non-food and non-energy — items responsive to the discount rate adjustments) of 8.9 percent, headline inflation of 12.7 percent for March and a Sensitive Price Index of 16.79 year-on-year for the week ended 31 March 2022. Clearly, the discount rate has been linked to headline inflation, a policy decision by the MPC since May 2019.
Be that as it may, Kibor has been close to around 3 percentage points higher than the discount rate — a factor that needed to be dealt with as the largest commercial bank customer, the government, was borrowing at a rate that allowed for banks’ windfall profits and in addition was providing an incentive for arbitrage.
While the rise in the discount rate implies that a contractionary monetary policy is in place yet what has to be understood is that the country’s fiscal policy remains expansionary and hence its impact on the rupee-dollar parity may be limited till such a time as the elected prime minister, whosoever he maybe, begins to reverse the policy. It is no doubt going to be perceived as political hara-kiri to reverse the 28 February relief package and the 1 March industrial package yet there is no other financially viable solution.
The MPS notes “risks to external stability have risen” — a fact evident from a continued improvement in the non-oil current account deficit. Notwithstanding this improvement in non-oil current account deficit the MPC decided to increase the interest on export refinance by 225 basis points — from 3 to 5.5 percent — and widened the set of import items (luxury items and excluding raw materials though the list will be announced soon) subject to cash margin requirements. Additionally, however, the “heightened political uncertainty contributed to a 5 percent depreciation in the rupee (from 178.6 rupees to the dollar on 8 March when the last MPS was announced to 188 rupees to the dollar on 7 April) and a sharp rise in the domestic secondary market yields as well as Pakistan’s Eurobond yields and CDS spreads.”
The decision to raise the discount rate indicates that the economic situation deteriorated considerably, with sceptics arguing that part of the reason for not raising the rates in March was pressure from the government (given the prevalence of de facto environment over the de jure construct subsequent to the passage of the SBP amendment bill that envisaged its autonomy), which made the continued use of the exchange rate as a shock absorber, as per the advice by the International Monetary Fund (IMF) in the sixth review documents, simply inadequate requiring an adjustment of the discount rate as well.
The MPC also noted that Pakistan’s external financing needs in the current fiscal year are fully met from identified sources. This statement, however, is critical for the IMF that has indicated it will engage with the new government as it was one of its conditions throughout the programme which was highlighted in the staff-level agreement of 12 May 2019 notably “financing support from Pakistan’s international partners will be critical to support the authorities’ adjustment efforts and ensure that the medium-term programme objectives can be achieved.” However, that support was identified at a whopping 38.6 billion dollars in just 39 months by the then economic team leaders, with 10 billion dollars used for budget support as acknowledged by the Finance Ministry recently in parliament. There is an emergent need for the next government to begin slashing expenditures and instead of raising taxes the key remains in widening the tax net. The decision to raise rates, however unpalatable for the productive sectors, was necessary but this decision needs to be urgently followed by policy decisions by the government on the fiscal side and slashing current expenditure. It is, however, needless to state that the economy appears to be the first casualty of current political strife in the country.
Copyright Business Recorder, 2022
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