The monetary policy is on Monday. As per Topline and Arif Habib Securities surveys, most market participants expect no change with the policy rate to taper off in the second half of this fiscal year. The policy rate stands at 15 percent, and SBP’s expected inflation is 18-21 percent for the fiscal year. This implies negative real rates on forward looking basis. The question is whether it's appropriate to continue with the current stance.
Though the real rates are negative, the discount rate is at a multi-decade high. Hence, it may not be appropriate to say that the monetary policy is strictly accommodative. But still, real rates are negative. The marginal savor in PKR is at a disadvantage, as keeping money in fixed accounts in banks is not enough to beat inflation. However, seeing that inflation expectation will be significantly lower in the next fiscal year, SBP can balance this with high real rates going forward by slowly lowering the nominal rates.
The other argument for not too tight monetary policy is that the fiscal house is strictly in a tightening stance. Taxation on individuals and corporates is exceptionally high considering the one-offs super tax. The development spending is to be compromised. And any change in the expenditure (or cut in revenues) must be met with additional taxes to keep the primary fiscal deficit within the budgeted limit. IMF is putting its foot down on it. This gives some room for monetary policy to be accommodative.
Demand tapering aims to work through fiscal, monetary, exchange rate, and administrative measures. However, there is a limit to what monetary policy can work in curtailing demand. Raising rates beyond a certain level could be counterproductive. Based on history, Pakistan’s rates are closer to the inflection point. However, the counterargument is that with negative real rates, people have an incentive to consume savings that are depleting in the real term. And that can boost demand.
Well, this psychological preponing consumption is more linked to the exchange rate. For instance, people tend to buy cars, phones, and other imported stuff to hedge against the PKR depreciation. Likewise, businesses buy higher inventory in anticipation of capital gains. That was happening and had contributed to $7 billion-plus imports in June despite the monetary tightening. But now, with a reversal in the PKR trend and currency administrative measures, imports are significantly curtailed – down by 37 percent from the previous month to $4.99 billion. Barring petroleum products, the imports are down by 16 percent to $3.6 billion.
Ad hoc administrative measures to cut imports are working – cars and phones production is reduced to half along with similar efforts in the other sectors. Then the building of oil inventories at peaking rates has resulted in lower imports. The price arbitrage is no more, and there is genuine demand reduction too. The demand is falling. And this will continue till the administrative measures are in place. The finance minister is saying these are in effect till September, but the buzz is these will continue till December.
This, coupled with lower oil prices and the coming back of the IMF, has put pressure off the PKR. That limits the need for a policy rate increase in managing the exchange rate. The risk of pent-up demand is there once these are opened. But by that time, the overall economic slowdown would have seeped in. Already it is visible from the sharp decline in cement, auto, and petroleum sales. Many other sectors are similar.
And the inflation will peak in August and is expected to fall after that. Thus, the 12M forward real interest rates would not be negative by September. And the argument of losing savings for consumption may lose weight. Therefore, seeing the tapering demand, expected improvement in current account deficit, discipline in the fiscal house, and currency adjustments, the doctor's order is to keep the policy rate where they are. The policy mix has started working. Don't overkill it.
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