The monetary policy meeting is due on Monday (12th June). The market is expecting no change, based on a few surveys and talks with analysts. And there should be no change in the policy rate which is at 21 percent. Some may argue that with inflation at 30 percent in the outgoing year whilst the currency under pressure, the rate should be hiked. Others argue that private credit is already squeezed, and lion's share of incremental system credit is going to the government, which is kind of insulated to rate hike, hence the policy rate should be lowered.
The real issue is unabated growth in inflation. Some say that inflation is like toothpaste- once it’s out, it cannot be put back. And there is seemingly no control on the growing inflationary expectations and anticipation of further currency depreciation. That is a dangerous trend. It is unprecedented in Pakistan. This needs some ingenuity of economic modeling that comes up with reasons of high inflation and solutions to control it.
This is SBP's job. However, in the past one year or so, the top three macroeconomists -including Governor, Deputy Governor and Chief Economists left the central banks and these are not replaced by macroeconomists. The need of vibrant and thinking economists is utmost in times where time-worn solutions will not work.
There is no one in the country to do deep analysis and pinpoint the reasoning of persistently high food and other inflation and come up with the tools to counter these.
Inflation based on the base effect has peaked at 38 percent in the last recording and is going to recede, due to the base effect and softening of the international commodity prices. However, one big caveat is that inflationary expectations are being built and that can only be curbed by controlling the depreciating currency andremoving the shortages that have been created through applying administrative control on imports.
Somehow these are linked to macroeconomic instability and political uncertainty. The IMF programme is in limbo, and that has further increased the chances of economic default. People fear hyper inflation and a free fall of currency. And in anticipation, prices are increasing, and savers are accumulating foreign currency by shaving off deposits in PKR – evident by Rs1.2 trillion rise in currency in circulation which as a ratio to monetary aggregate (M2) at 30 percent versus at 27 percent in the start of the fiscal year.
The demand side is curbed. LSM is down by 8 percent in 9MFY23 and it’s down by 25 percent in recent recordings. Electricity and petroleum consumption decline is in double digits. And the situation is the same across various sectors. Private credit is down by 1 percent (YoY) while the M2 is up by 14 percent at a time when inflation is touching 30 percent. All the growth is coming from fiscal deficit financing (up by 25%) and quasi fiscal financing (commodity financing – up by 25% and PSE credit up by 17%).
Seeing this, there are no reasons for any rate hike to curb demand. In fact, given the sharp contraction in LSM, any further rise in interest rates could result in some companies to default on banking credit. However, the defaulting government is borrowing with both hands without giving any heed to rising financing costs.
An expansionary fiscal policy is the prime reason for bringing this high inflation which is coupled by delayed monetary response. In FY22, fiscal primary deficit was a whopping 3.1 percent -highest deficit in 9 years. This at the time of rising global commodity prices resulted in high inflation. Since SBP was behind the curve, it could not arrest the rising inflation trend.
Now the situation is a bit better on the fiscal side, there is marginal primary surplus in 9MFY23, and the full year would be in balance. The key is to have a contractionary fiscal policy and it should be reflected in the upcoming budget. The government should come up with a large primary balance by taxing the untaxed, cutting the bloat in federal, provincial government and PSEs. Otherwise, inflation tax will keep on haunting 240 million inhabitants at the cost of tens of thousands of beneficiaries.