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There is a conflict between pricing instruments (exchange and interest rates, and in turn inflation), and the structural reforms (fiscal, energy etc). The logical fallacy created by Dar – that changing prices balloons deficits - needs to be corrected. In simpler words, the focus should be on correcting structural imbalances, pricing instruments are mere tools to do so.

The pricing decisions are to be taken with care and should have the best economic minds in the country to take the onus. Asad’s response on pricing movements on Friday, is that these are central bank domain and the SBP is independent for its decisions. That is true on paper and let's hope the functioning will be in spirit soon.

However, before true giving independence to SBP, the finance minster should pay heed to building capacity of the institution. All the top economists in the country are revolving around finance and prime ministers in various advisory roles; but no top name is in the monetary policy committee or in the SBP board.

The central bank governors/heads in many countries are top economic minds with strong connection to global economists’ fraternity. Indian Reserve Bank Governor Urjit R Patel is an economist by training and has worked in the IMF and private sector before assuming the role. Same is the case for many other economies.

PM and FM need to introspect where Pakistan stands. Why aren’t the best economic minds sitting in the SBP monetary policy committee? Giving premature power to central bank can be counterproductive and keeping a blind eye on the institution's capacity is the inability of FM to grasp ground realities.

The sane way is to slowly pass on policy anchoring to the SBP along with building capacity at monetary policy committee - the PM yesterday said that the government is forming a 'mechanism' to ensure that the central bank does not devalue currency without informing the government. At least the PM is being honest in anchoring the policy; as this has been the undisclosed role in the past.

However, this should be a stopgap solution till the capacity is built at the SBP to assume true independence The natural progression should be to anchor the exchange rate policy in a transparent way to some economic indicators. The ideal case is to let the currency to be free floated; but that can create panic; it is better to peg it to some economic indicators. REER pegging is a viable stopgap solution. For details read "Dollar dairy: Don't go the Dar way" published yesterday.

Another relevant debate should be on the monetary policy and its implication. The SBP has surprisingly increased the policy rate by150 bps to 10 percent last week. The market was expecting a rather less hawkish stance seeing the oil prices movement. It seems like the MPC decision was premeditated and it lacked dynamic thinking - it raises question on the strength of monetary policy committee.

Having said that, analysts are wrong in computing the impact of interest rate hike and currency depreciation on the fiscal deficit - for example 1.5 percent increase in interest rates does not proportionately increase the fiscal deficit. Yes, it will increase the debt servicing by around R200-240 billion (multiplying Rs16 trillion domestic debt by 1.5%); but out of it, Rs6.5 trillion (40% of domestic debt) is SBP's and it will come back to government in revenues in the form of SBP profits.
Similarly, around 40 percent of banks’ incremental earnings on government short term papers will come back to government in form of taxation. Then, the impact of higher rates is much lower on permanent and unfunded debt.

Similar calculation errors are made in computing foreign debt liability. Dar created this fallacy of direct correlation of foreign debt servicing with currency parity - by saying that one percent depreciation in currency increases the foreign debt by one percent in rupee amount.
That is incorrect - foreign debt servicing is in foreign currency and it has to be equated with country's (government) capacity to pay in foreign currency. In simple words, it is linked with the SBP foreign exchange reserves; and both interest rates and currency rates are adjusting to build foreign exchange reserves.

The focus should be more on structural reforms and less on pricing. Dar kept on running the economy on steroids and now business community is addicted to injections by eying short term gains in stock and real estate markets.

There was no decent private sector green field investment both by domestic and foreign investment, but in the guaranteed return power sector. If the currency reaches its fair value, and structural issues are resolved, the investment can pour in. But it will take some pain.

Copyright Business Recorder, 2018


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