Shallow easing?

EDITORIAL: Monetary Policy Committee (MPC) in its scheduled meeting yesterday reduced the policy rate by 150 basis points – from 22 to 20.5 percent – a decision indicative less of domestic and more of multilateral pressure specifically the International Monetary Fund (IMF) that the government is currently engaged with in negotiating a longer term “successor” programme projected to be effective from the start of next fiscal year on 1 July.

The contention that the attempt to ease domestic clamour for reducing the rate was cosmetic is strengthened by the fact that in spite of the reduction in the rate the differential between the policy rate and the April Consumer Price Index (CPI) of 11.8 percent is an unprecedented 8.7 percent while it is an equally unprecedented 8.2 percent when compared with core inflation of 12.3 percent.

The MPC rationale as noted in the Monetary Policy Statement (MPS) is that “while the significant decline in inflation since February was broadly in line with expectations, the May outturn was better than anticipated earlier.” Two observations are relevant.

One, the MPS notes that real Gross Domestic Product (GDP) growth remained moderate at 2.4 percent in FY24 as per provisional data – a rate that was painstakingly and a tad suspiciously projected after the 28 March 2024 decision to review the growth estimates for the first two quarters of the year in the 108 National Accounts Committee (NAC) meeting followed less than a month later on 21 May with the upgraded rates announced in the 109th NAC meeting. The first quarter growth was upped from 2.5 to 2.71 percent and the second quarter from 1 percent to 1.79 percent.

And second, the dramatic decline in inflation from 17.3 percent in April to 11.8 percent in May had no feel good factor for the general public mainly because it was widely seen as understated indicated by the fact that instead of taking the average tariff the lowest subsidised electricity tariff rate was taken and the rates for essentials were those that were subsidised for sale at Utility Stores but at which the commodity was not available or of poor quality not fit for human consumption as in the case of wheat.

It is important to note that the MPS foresees a risk of inflation to rise significantly in July 2024 - a time period coinciding with the expected IMF (International MonetaryFund) programme approval with implementation of prior conditions (inclusive of administrative measures to raise utility rates to meet full cost recovery and raising taxes in the indirect mode whose incidence on the poor is greater than on the rich) but adds optimistically as in all previous post June 2022 MPS that the inflation uptick will be “trending down gradually from the FY25.”

The IMF, on the other hand, insists that a policy rate must be in the positive realm to reduce inflation, a logic backed by basic economic theory. The MPC has noted that the real interest rate still remains significantly positive, which is important to continue guiding inflation to the medium term of 5-7 percent – a target that has not varied since the past few years though the medium term remains undefined.

The positivity of the policy rate is determined by its difference with inflation and therefore the justification for a decline of only 150 basis points sounds hollow. Besides the Fund logic does not apply in Pakistan’s case for two reasons: (i) a high policy rate raises capital borrowing costs and therefore is a disincentive to large-scale manufacturing sector – a fact reflected by the negative private sector credit growth as per government data for the past three years; and (ii) massive government borrowing to fund current non-development expenditure has compelled administrations to borrow domestically as well as internationally which, at a high rate, simply jacks up the debt servicing component of the budget, another highly inflationary policy.

What is very disturbing is the MPC recommendation that “going forward, the Committee stressed that timely mobilisation of financial inflows is essential to meet the external financing requirements and further strengthen foreign exchange buffers for the country to effectively respond to any external shocks and support sustainable growth.”

This approach appears to mirror that of the IMF that since 2019 Extended Fund Facility(EFF) programme has made the acquisition of foreign loans (including rollovers) a precondition for each tranche release and the source of strengthening foreign exchange reserves. And again like the Fund the MPS argues that “fiscal consolidation through broadening the tax base and reforming loss making public sector enterprises would help achieve fiscal sustainability on a more durable basis.”

Indeed it would, but in the short term the government should be advised to massively slash its current non-development expenditure on a priority basis rather than widen the tax net which reports indicate is going to entail widening the ambit of indirect taxes as opposed to bringing the untaxed into the tax net and with the economy fragile this is perhaps not the appropriate time to garner private interest in managing or purchasing loss-making units.

Copyright Business Recorder, 2024