EDITORIAL: The Monetary Policy Committee (MPC) decided to keep the policy rate unchanged at 22 percent surprising several economists who had argued that the International Monetary Fund (IMF), as a critical component of the 3 billion dollar, nine-month Stand-By Arrangement (SBA) approved on 12 July 2023, would require a raise in the rate premised on irrefutable economic logic: the differential between the policy rate of 22 percent and the August Consumer Price Index of 27.4 percent indicates that the real rate remains in the negative territory.
This obvious realization led to the Monetary Policy Statement dated 14 September to maintain that “real interest rates continue to remain in positive territory on a forward looking basis;” the reference to forward looking basis would no doubt be the argument put forth to the Fund as and when the first mandatory staff level review of the SBA begins.
There is little doubt that if the IMF insists that raising the discount rate is a prior condition for the release of the next tranche the MPC would promptly oblige even if it requires bringing the scheduled date of the next meeting forward.
The argument that inflation outlook will improve going forward and May 2023 rate of 38 percent was compared to the August 2023 rate as proof yet the MPC needs reminding that at the time inflation was 38 percent the policy rate was 21 percent while with inflation 10.6 percent lower the rate is 22 percent. Perhaps this necessitates an explanation from the MPC.
To further complicate matters economists/statisticians contest the inflation data released by the Pakistan Bureau of Statistics for August when measured against the July rate of 28.3 percent for two reasons: (i) core inflation remained unchanged for the two months at 18.4 percent even when the month-on-month rate for urban rose by 0.6 percent and rural by 1.6 percent in August in comparison to July; and (ii) CPI takes account of imported inflation and in this context it is relevant to note that the rupee- dollar parity in July was 281 while in August the rupee depreciated further to 294.5 rupees to the dollar. So the question is does the MPC’s decision to keep the rate unchanged reflect the economic conditions or is the result of overt or covert influence from the stakeholders?
The central bank is perceived to have been prone, in the past, to take decisions under pressure that are at odds with the economic data – a charge with particular reference to controlling the interbank rupee-dollar parity from October 2022 till the staff level agreement was reached in June this year which accounted for a 4 billion dollar drop in remittances as the illegal hundi/hawala system was rejuvenated.
The question is: was there any pressure on the MPC to keep the rate unchanged? There are three references in the statement issued by the MPC on the crackdown against speculators/smugglers in the foreign exchange and commodity markets – a crackdown that began on 5 September, notably: (i) “recent administrative measures against speculative activity in FX markets would support the inflation outlook” - a contention that can be fully supported, however, with the price of electricity, gas and petroleum products expected to be raised further, the optimism with respect to a lower rate of inflation maybe misplaced at least in the short term; (ii) “recent regulatory measures aimed at improving availability of essential food commodities and curbing illegal activities in the foreign exchange market have begun to yield results.
This has helped in narrowing the gap between the interbank and open market exchange rates,” but economists are legitimately concerned that the rupee appreciation would encourage imports with a consequent negative impact on the current account deficit as well as not being in line with the Fund’s assessment of the rupee’s real effective exchange rate; and (iii) “as per latest surveys near term inflation expectations of both consumers and businesses have reversed from their earlier declining trend. The Committee noted that these results partly reflect the impact of heightened uncertainty in the foreign exchange markets – particularly in the open market – at the time these surveys were conducted…recent regulatory and law enforcement measures will help address supply constraints in commodity and illegal activity in foreign exchange markets.”
This assessment veers towards an optimism that maybe misplaced at least in the very short term (September and October 2023) given that large-scale manufacturing (LSM) growth was estimated at negative 15 percent in 2022-23 (against positive 11.6 percent in 2021-22) and negative 10.3 percent in June 2023.
While data for July has not yet been released yet, there is little indication that it would register a positive trend largely because the cost of credit (an input for LSM) remains prohibitively high and additionally, government borrowing crowded out private sector borrowing last fiscal year which accounted for a drop of 178.6 percent.
The MPC correctly argues that “going forward, expected fiscal consolidation, realization of planned external inflows and uptick in economic activity would provide space for a moderate expansion in private sector credit this year,” but attainment of these objectives requires structural reforms that the outgoing government did not initiate and which the Caretakers have yet to initiate after one month in the job.
And finally, the MPC noted that better input conditions and latest updates indicate that the outlook of the agriculture sector has improved. Earlier concerns related to floods have subsided and cotton arrivals almost doubled from last year.
Two observations are in order; notably, last year the devastating floods set a particularly low bar on farm output and secondly, the positive outlook for agriculture is based in a massive rise in credit to the sector through subsidised credit lines under various schemes initiated for political reasons by the eleven-party coalition government.
In July 2023 total farm credit was 151 billion rupees against 111.8 billion rupees in July 2022, a 35.1 percent increase. We hope that the rise in credit is translated into higher output; however, one would have to wait for firm output data before concluding that this has indeed materialised.
Copyright Business Recorder, 2023