Unchanged policy rate

Citing improvement in major macroeconomic indicators of the economy, the newly-formed Monetary Policy Committee (MPC) decided on 30th January, 2016, to keep the policy rate unchanged at 6.0 percent for the next two months. According to the Monetary Policy Statement (MPS) issued after the meeting, "inflationary environment stayed benign, LSM gained traction, and fiscal consolidation remained on track. In addition, successful completion of ninth review under the IMF's EFF and disbursements from multilateral and bilateral sources added on to the country's external buffers. The pickup in private sector credit, for fixed investment in particular, along with improving security situation, reflects strengthening of investor and consumer confidence." Average CPI inflation declined to 2.1 percent during July-December, 2015 but the trend in YoY CPI inflation which rose for the third consecutive month to 3.2 percent in December, 2015 has reversed. SBP expects the average inflation during FY16 to remain in the range of 3 to 4 percent. LSM grew by 4.4 percent during July-November, 2015, as compared to 3.1 percent in the same period of last year. However, there are challenges to overall economic performance due to a decline in the production of cotton and rice but overall, real GDP is set to maintain the previous year's growth momentum.
Current account deficit narrowed to almost half of last year's level during July-December, 2015 on account of a persistent decline in international oil prices and a steady growth in remittances. With a depressed outlook of international commodity prices and continuation of the IMF's EFF together with expected disbursements from official sources and increase in FDI from China, surplus in capital and financial accounts may increase in the second half of FY16 that would help maintain an upward trajectory in foreign exchange reserves. Reversing of a declining trend in exports would, however, will be dependent on external demand and cotton prices in the international market. Fiscal deficit was contained to 1.1 percent of GDP during July-December, 2015, compared to 1.2 percent in the same period of last year due mainly to improvement in tax revenues and containment of current expenditures. Additional tax measures announced in October, 2015 were expected to increase FBR revenues. The year-on-year growth in broad money (M2) accelerated largely due to a substantial increase in Net Foreign Assets (NFA). The growth in Net Domestic Assets (NDA), on the other hand, decelerated despite a pick-up in private sector credit. Deceleration in growth of deposits and acceleration in currency in circulation were, nonetheless, a source of concern. Monetary easing, improved financial conditions of the major corporate sector and better business environment encouraged firms to avail credit both for fixed investment and working capital requirements.
The MPC decision regarding the policy rate and analysis of the economy in the MPS were keenly awaited this time because it was for the first time in the history of the country that, instead of SBP's Board of Directors, an independent MPC was legally assigned the job of monetary policy formulation. This change was made after amending the SBP Act, 1956 in November, 2015. The newly constituted MPC comprises 9 members, including three members of the Board nominated by the Board itself, three SBP staff members and three economists as external members, with Governor, SBP as the Chairman. As is well known, such a change has been effected under pressure from the IMF to enhance SBP's autonomy. However, the question whether such a change would bring about the desired result has no easy answer because now about one-third of the MPC would consist of outsiders who may or may not agree with the viewpoint of the SBP. Anyhow, the decision to keep the policy rate unchanged at 6.0 percent seems to be quite reasonable and fair while the positive spin given to most of the analysis in the MPS appears to be an effort aimed at appeasing the government and toe its line. As is obvious, the MPS is quite optimistic about growth rate, easing of inflationary pressures, fiscal outcome, LSM growth, external sector developments, and level of foreign exchange reserves. Seen through the prism of the MPS, it would seem that there is nothing wrong with the economy and Pakistan is well poised to move to a higher growth trajectory. If the fundamentals of the economy are so strong, there is a reason to rejoice about the bright future waiting for the citizens of this country. Realistically speaking, however, there are still a number of infirmities in the economy that are well-entrenched and would need a lot of time and efforts to redress them in a proper manner. The MPS says that "real GDP is set to maintain the previous year's growth momentum" but, given the present rate of increase in population, such a momentum would not result in prosperity but leave us far behind the regional economies for a long time to come. Apparently, if the saving and investment rates in the economy continue to be dismal, there is hardly any chance of increasing growth, promoting employment and alleviating poverty. Similar is the case with external sector accounts. A great deal of improvement in this area is because of exogenous factors. International prices of oil have declined steeply, home remittances are expected to reach a record level of dollar 20 billion this year and there is continued inflow of foreign resources from a variety of sources. All these sources of comfort to the balance of payments are not in our control and not likely to last forever. A substantial increase in exports and FDI which could have led to a sustainable improvement in the external sector accounts is nowhere in sight, at least at this point in time. Improvement in fiscal outcome as stated in the MPS is only marginal and hardly believed by some prominent economic analysts. SBP, however, has expressed some concerns about deceleration in growth of deposits and acceleration in currency in circulation. Continuation of this trend could adversely affect the saving rate in the economy and banking industry of the country. It was in the fitness of things, if an autonomous MPC would have given a more balanced view of the economy. It was all the more necessary because an analysis of the SBP is believed to be much more objective and credible than the government hierarchy.
Insofar as the change in policy rate is concerned, the case for a slight downward adjustment in the policy rate or keeping it unchanged at the existing level was almost equally balanced. While factors like acceleration in LSM growth rate, easing of inflationary pressures, a reduction in fiscal deficit and a lower current account deficit favoured a reduction in the policy rate, the recent pick-up in the inflation rate, depreciation of exchange rate and deceleration in the growth of deposits and acceleration in currency in circulation have called for a more cautious approach. An acceleration in M2 in the midst of a lower GDP growth rate could also ignite inflationary pressures in country's economy; which are needed to be countered by adopting a tough monetary stance. As such, it is better to wait and see before making the next move on monetary policy. Also, there is no need to ease monetary policy further when there is already a reasonable pick-up in private sector credit both for investment and working capital requirements to boost economic growth prospects.