Since the beginning of current financial year, the State Bank of Pakistan has maintained the benchmark interest rate at 22 percent. In the three meetings of Monetary Policy Committee (MPC) over the past five months, SBP has reposed confidence that its policy stance is appropriate, based on forward-looking expectations of headline inflation maintaining a downward trend throughout the fiscal year.
In fact, in its July meeting, the MPC projected an “average inflation in the range of 20 – 22 percent in FY24”, in line with the 21 percent inflation rate used by the federal government in preparation of its annual budget estimates. But is the inflation target achievable?
During the first five months (Jul – Nov 2023) of the current fiscal year, inflation rate has averaged at 28.6 percent, compared to period average of 25.1 percent during the preceding fiscal year (Jul – Nov 2022). The central bank insists that the annual inflation would fall dramatically in the later half of the fiscal year, once the elevated base effect from Jan – Jun 2023 kicks in.
But the central bank’s optimist forecast ignores that on month-on-month basis, the headline CPI has been rising at an average rate of 2.2 percent during 5M-FY24, which is at par with the average month-on-month inflation rate during 5M-FY23. This in turn has brought the year-on-year average rate close to 29 percent during the Jul – Nov 2023 period, despite an already elevated base effect from the same period last year.
Now, in order for the average inflation to decline to the target of 21 percent for the full year, month-on-month inflation rate will in fact have to turn negative for the remainder seven months of the financial year, recording a period average of -0.5 percent from Dec 2023 to June 2024. For context, the period average month-on-month rate during the same period last year was 2.15 percent. In fact, based on available data, month-on-month period average rate for Dec – Jun has not once been negative, at least not since FY18 (based on new CPI base 2015-16).
Even under a best-case scenario where month-on-month average during Dec – Jun falls to 1 percent (from the current 2.2 percent during 5M-FY24), average annual inflation reading would come in at 25 percent, four percentage points above the target rate. This in turn means that the policy rate will have been negative all of FY24.
Yet, positive market sentiments over the past few weeks seems to indicate that the days of monetary tightening should now be behind us, and a rate cut is now overdue. This market sentiment has in part been fueled by the administrative state action against speculation in the currency market, timely completion of IMF review, and, lastly, what could only be termed positive ‘vibes’ of planned FDI from the Gulf countries. What the merchants of exaggerated optimism fail to spell out, however, is that a premature rate cut would be pushing Pakistan into a monetary expansion cycle long before advanced economies do so, which would raise pressure on the exchange rate to let off the steam from rising inflation differential.
It has been over three years since the central bank brought down the benchmark interest rates into negative territory back in June 2020. Ever since, the Monetary Policy Committee (MPC) has met 25 times, averaging a meeting every 45 days. During this period, the policy rate has been raised by 15 percentage points. Each time, the central bank assures the market participants that the real rate is now positive on forward looking basis. Yet, the real rate has consistently remained negative throughout this period.
The central bank has fallen short of fulfilling its primary mandate of inflation targeting since the beginning of the pandemic. However, the extraordinary times are now over, at least for the rest of the world. Covid is behind us; as are the supply chain disruptions, commodity super cycle, spillover from Russian invasion of Ukraine, monsoon floods of 2022, and the risks of immediate debt restructuring for Pakistan’s economy. Global energy prices have also remained resilient in the face of conflict in the Gulf. The central bank will have little excuse, if any, to fail to meet its inflation target yet again in FY24. And maintaining – or worse, amplifying negative real rates – will only serve as a death nail in the coffin of SBP’s medium term target of 5 – 7 percent over the coming years.
Beware!
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