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EDITORIAL: Murtaza Syed, Acting Governor State Bank of Pakistan, in an interview with a local media outlet, conceded that the Bank was targeting an inflation of 18 to 20 percent on average for the current fiscal year — a projection that is more realistic than the 11 percent projected in the budget documents subsequent to the implementation of “prior” conditions, which included raising utility rates, petrol and petroleum products, leading to the 13th July seventh/eighth staff-level agreement with the International Monetary Fund (IMF).

It is therefore relevant to note that while on average, headline inflation (Consumer Price Index) was around 13 percent from January till May 2022 it jumped to 21.3 percent in June and 24.9 percent in July.

CPI includes imported items, particularly petroleum and cooking oil (major import items for Pakistan), whose international prices were rising till May early June while the rupee was eroding its value against the US dollar. In other words, imported inflation was a significant component of domestic headline inflation calculation.

The SBP’s capacity to deal with headline inflation is limited to tackling disorderly market conditions in the currency market as per the agreement with the IMF, defined as extreme volatility in the exchange rate patently evident in this country in June and July.

The SBP deals with this volatility through tightening controls over legitimate dollar releases — a policy decision it unfortunately delayed till July. It is, however, important to note that the rupee correction is now ongoing and one would hope that the SBP reverts to the pre-2019 policy decision, i.e., to link the discount rate not to headline inflation but to core inflation which includes non-food and non-energy items that can be adjusted through policy rate adjustments.

Core inflation as per the Pakistan Bureau of Statistics (PBS) has not been as volatile as headline inflation — from the March figure of 8.9 percent to 9.1 percent in April, 9.7 percent in May, 11.5 percent in June and 12 percent in July. Prior to 2019, the policy rate was within the range of plus/minus maximum 2 to 2.5 percent.

In 2019 prior to the onslaught of the pandemic, the policy rate was 13.75 percent with a headline inflation projected at around 13 percent by the Fund, with core inflation way lower at around 8 percent. The policy rate today is 15 percent — 3 percent higher than the core inflation. If core inflation does not rise in August the market may well assume that the Monetary Policy Committee scheduled to meet on 22 August would not raise the policy rate further as feared by some market players, speculating that the SBP may have agreed to further raise rates with the Fund.

The IMF is unlikely to upload details of the agreement with the Pakistani authorities till after its board’s approval of the tranche release, expected in last week of August, and hence a definitive answer will not be available till after the MPC meeting. There are disturbing reports from the market that the rate on offer is close to 17 percent for the government paper and higher for the private sector which strengthens the view that the MPC may raise the rate further.

However, a word of caution is in order: raising the discount rate would cripple economic activity, specifically the large-scale manufacturing sector with obvious negative repercussions on unemployment and poverty levels.

We would hope that a valuable lesson has been learned by the SBP notably that linking the policy rate to headline inflation will not check imported inflation though it would certainly check aggregate demand, thereby impacting severely on the quality of life of the poor and the vulnerable.

Copyright Business Recorder, 2022


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