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EDITORIAL: Monetary Policy Statement (MPS), has not been much successful in justifying the 100 basis point increase in the policy rate as an outcome of “slightly deteriorated inflation outlook” due to a 300 billion rupee adjustment in the budget proposed on 24 June (after Prime Minister Shehbaz Sharif’s meeting with the Managing Director of the International Monetary Fund in Paris) and was passed by the National Assembly the next day on 25 June 2023 - a Rs 215 billion upward revision in taxes/duties/petroleum development levy rates and an 85 billion rupee reduction in expenditure.

Lending further credence to this general perception is the fact that the meeting of the Monetary Policy Committee (MPC) on 27 June was an emergent unscheduled meeting and, in addition, while the web manager removed all further scheduled meetings from the Calendar uploaded on the State Bank of Pakistan website, perhaps on the expectation of further emergent meetings, yet rather ineptly failed to remove the claim that “dates for the next five meetings are as follows.”

Thus the general consensus that the decision was part of the last-ditch effort to successfully persuade the lender of last resort to unlock its lending to Pakistan proved to be true.

This indeed is the shortest-ever MPS released comprising four paragraphs that reiterated SBP’s expectation that the ongoing IMF programme would be completed. Furthermore, the MPS maintains that the MPC will carefully monitor evolving economic developments and stand ready to take “appropriate action to achieve the objective of price stability over the medium term.”

While economic theory does indicate a strong linkage between the policy rate and the rate of inflation, this, however, does not fully apply to Pakistan for two reasons: (i) imported headline inflation is significant due to heavy reliance on imported fuel as well as cooking oil (which responds to the rupee-dollar parity rather than the policy rate).

This fact prompted the SBP to link the policy rate to core inflation (non-food and non-energy), a strategy that was abandoned in 2019; however, with core inflation for May at 20 percent (urban and rural) having risen steadily each month from 14.4 percent in September, the need to revisit policies post-September is acute. And (ii) a rise in the policy rate cripples private sector demand for credit, with obvious negative repercussions on growth, but more pertinently our government continues to borrow heavily from the domestic market as has been evident since October last year, thereby raising the markup component of current expenditure and has been injecting this money (not backed by productivity) into the economy thereby fueling inflation further.

It is high time that the MPC acknowledges that the government’s contribution to fuelling inflation is a lot more critical in Pakistan than in the West and that manipulating the policy rate will have very limited impact, if any.

And finally, the MPS claims that the 22 percent policy rate is to keep real interest rates in the positive territory on a forward looking basis. In this context the Central Directorate of National Savings, mobilising funds from the general public but a source of borrowing exclusively for the government, hiked rates in the first week of April this year but they remain well below the policy rate.

While the IMF staff clearly continues to adhere to the economic principle that policy rate manipulation deals effectively with an overheated economy yet a more powerful tool to bring the heat down in countries like Pakistan is to insist on capping government domestic expenditure funded by borrowing – domestic and external; or, in other words, the focus must revert to the budget deficit rather than on the primary surplus (a focus that partly explains the massive increase in borrowing post-July 2019) that does not take account of interest payments that are rising as a percentage component of current expenditure.

Copyright Business Recorder, 2023

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wanker Jul 02, 2023 07:11pm
The SBP called a 6.5% of GDP fiscal deficit mildly contractionary. It continues to enable the government profligacy.
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