The SBP is full of surprises. Inflation has inched up to 30 percent in September; the currency market is hovering around 300; international oil prices are above $90/barrel; confidence in holding PKR is eroding; the cut-off yields were up by 2 percent in the last T-bill Auction. And yet, the SBP has held the policy rates unchanged at 22 percent.
The question is what is driving this confidence at SBP? Well, a comment by a political analyst (not at all econ-savvy) summed it up – “Remember the business community went into the meeting (with the COAS) worried and came out confident”. Slippage in the exchange rate and rise in the interest rates were the two main worries of the business community. And these (for the time being) have been taken care of.
Between the lines, the message is that the plight of the PKR is being controlled through administrative measures. The rise in agriculture prices is being taken care of by administrative measures too (plus SBP is also expecting better agriculture crops). These reasons are enough (in SBP’s view) to ease the inflation in the second half despite the oil prices expected to reach $100.
The business community is all praise for the decision. And frankly speaking, there are merits to doing nothing. The pain point is eroding confidence in the currency and that is un-anchoring the inflation expectations. And 2-3 percent won’t cut it. Those who are not holding PKR at 22 percent may not do so at 25 percent.
You need to do more (make the real rate positive in September – not forward 12 months, inflation). But then, a large chunk of folks is not keen on earning fixed income (even in Islamic funds or banks) for religious reasons. You need to do something else for them to restore confidence.
As the SBP has not been proactive in its approach - remaining consistently behind the curve and chasing four straight years of the medium-term inflation target of 5-7 percent while the inflation makes new records, and the currency reduces its value to half in two years - there is not much that can be done by a mild increase of 2 percent.
However, increasing big could have dented the Dollar demand. And, the fiscal problem could have been worse. Already, private credit is shrinking, and delinquencies have started. Any further increase could have worsened the fiscal situation and private sector.
There is a need to bring the fiscal house in order and cut its expenditure. According to an ex-SBP Governor, 2/3rd of federal and provincial governments’ staffing is redundant. We need to cut the slack there. We need to bring austerity through reducing working hours and other measures. And we have to expand the tax base. However, these measures don’t come in SBP’s domain.
SBP’s domain is to stabilize the currency. Here, perhaps, SBP is relying on administrative control (danda) on smuggling and dollarization, which is making the open market bullish. And the interbank must chase due to IMF’s condition. The open market is taken care of by the forces, as of now, while interbank is being managed by banks’ liquidity, as SBP doesn’t have anything to burn, for some time.
The bottomline is that the SBP is still short of $8 billion in financing external debt repayment, and then some more is required to fund the to-be current account deficit. No forceful action in the country can generate that. It’s a fundamental problem. And not even SBP raising rates by 5 percent can do any good.