Won’t be long before default is on the table

SBP (State Bank of Pakistan) has no choice but to raise the interest rate, most likely by another 100 basis points, when the MPC (Monetary Policy Committee) meets on May 23.

The market needs to adjust to the inevitability of high inflation because whether the PM comes out of his denial and removes the petrol subsidy to resume the IMF (International Monetary Fund) bailout programme, or remains paralysed by fear of public disapproval; prices will rise regardless. And a torrent of inflation will most likely hit the people around mid-late summer.

The 10-15-odd-percent people that polls are showing expecting no change in this setting are most likely businesses desperate to grow out of trouble, hoping a variant of the Turkish model of a dovish policy in the face of rocketing inflation would work here when it failed there and humbled President Erdogan into eating his words about the Saudi crown prince and going begging bowl in hand to Riyadh.

If there are two monetary/fiscal lessons to learn from what the economy went through during the PTI (Pakistan Tehreek e Insaf) administration, they are, one, IMF is not going to buy into the idea of letting some subsidies stay because of some political imperative, so it’s not a good idea to build hope, or worse, policy, around that idea.

And two, what they said about fiscal and monetary policies being unable to move in completely opposite directions at the same time was right after all. Imran Khan did what he could to keep the fiscal tap flowing, even delivering a budget that had to be toned down through a mini-budget, but eventually prices only exploded unnecessarily to the upside and nothing good came of it.

Let’s not forget that now it’s not just domestic pressures on prices that we have to worry about. The commodity super cycle in intentional financial markets is quite well advanced and entrenched. And at least two developments, completely outside Pakistan’s control, continue to make things worse for us every day.

One is the fact that Hungary is expected to finally cave into EU (European Union) pressure at the foreign policy summit on May30-31 and accept a ban on Russian gas import into the continent. Since they haven’t nearly worked out alternate supply sources, markets are understandably anxious enough to push large oil importing countries right to the edge.

And the other is the mysterious strengthening of the US dollar just when the Fed is beginning a tightening cycle. Textbook market correlation tells you that the dollar will fall when commodities rise and the central bank is forced to turn hawkish. Yet the dollar index has just touched highs not seen in two decades.

Even though the Fed is back to tightening as well, the real interest rate there is still so far in the negative that it’s pushing investors to wonder if watching inflation is still its primary mandate, and if it hasn’t been replaced by a desperate need to strengthen the dollar.

Considering how the Ukraine war led a few countries to trade out of the dollar, using currencies like the ruble and yuan instead, and how some of the Gulf’s petro economies were also considering tilting this way, the mad rush to breathe more life into the greenback, even if real policy is hawkish more in rhetoric than in numbers, is very understandable, even predictable.

All that means that not only will there be no more subsidies at home, but oil (and other commodities like wheat) will get more expensive, the strong dollar will beat more life out of the rupee, the current account will come within frightening distance to implosion, and prices will definitely rise higher, just to green light one more tranche from the Fund.

There will, or at least should, be another spike in the interest rate alright. And even if we manage to survive this round, it’s pretty clear that sustained borrowing is no longer possible, and overcoming the deficit on our own is not going to happen anytime soon. So, it probably won’t be very long before a contained default is on the table.

Copyright Business Recorder, 2022