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The economic team, including SBP, is taking too much time to make moves, and in the process taking some unwarranted decisions. The disposition was not much different for previous regimes; but the learning curve is proving to be too costly as there are not many external and fiscal buffers to have the liberty to learn by doing.
One of the critical policy decisions is of setting interest rates where the tightening is overplayed and the policy discourse might have more adverse consequences. The July-December inflation is standing at 6 percent, the 12 month moving average is 5.1 percent and the SBP expects full year inflation between 6.5-7 percent. The core inflation is 8.3 percent and its 12-M average is at 7.1 percent; and the depressed oil prices outlook means lower inflationary expectations.
Whatever lens the monetary policy committee (MPC) is using, there is no way to justify policy (target) rate of 10.0 percent and discount rate of 10.5 percent. It is hard to find economic rationale for having around 400 bps real interest rates when the medium to long term objective is to have higher economic growth and generate employment for around two million youth coming into job market age every year.
The objective of tightening is to curtail domestic demand to compress imports and to control inflation in days of sharp currency depreciation. In case of demand, non-essential imports are to be cut by currency adjustment and other tariff and non-tariff barriers. The interest rate hike is mainly for compressing consumer financing demand which is a mere 3-4 percent of total banking credit. The biggest jolt is to be felt by the government of Pakistan, with a share of over 60 percent in direct and indirect banking credit.
The marginal benefit of interest rates increase on curtailing consumer demand diminishes once the real rates are in positive territory, while the adverse impact on government domestic debt services magnifies. The debt servicing increases proportionately with interest rates hike and higher servicing leads to accumulation of more debt which fuels future debt servicing. We have been there before. There is a debt trap looming.
There are other ways to cut imported and domestic demand - by increasing taxation on petroleum prices, duties on cell phones and imported cars, tax on automobile financing, etc. Such measures not only cut demand but also jack up government revenues. The macroeconomic objective is to lower twin deficit (fiscal and current account), and targeted policy measures can do both. On the flip, plain vanilla interest rates hike is doing more damage to fiscal balance than it is improving current account.
The coordination between fiscal and monetary policies is weak and the SBP is apparently acting on its own to take all the decisions. And if the MoF is on the same page, probably the IMF conditions are being blindly followed without scenario analysis.
The MPC committee seemingly lacks capacity. In 2009, when MPC was first formed, the external members were Dr Hafiz Pasha and Dr Ijaz Nabi - arguably the best economic minds in the country. From SBP's own team, there were rising starts like Hamza Malik and Asad Qureshi, and the experienced Riaz Raizuddin.
The current committee, constituted in 2016, was not able to read the challenges posed to macroeconomic stability in 2017, and was late to react in adjusting interest rates. And now, the stance is too hawkish while the incremental challenges are required to deal with innovation.
The MPC, constituted in 2018, has 10 members, including three external economists, three members from SBP board and four members from SBP team. The MPC is due to be reconstituted by Mar19 with two external economists completing term in January and third in March. The three external members part of MPC are also completing their term on SBP board in Mar19. The government is required to reconstitute the committee by having strong independent economists and board members.
The issue is not only of capacity but also undue political interference in Dar times which had led to a few leaving SBP and others to remain silent. Once the 'good news' of rate cut was announced by Dar on TV, before the statement was released by the SBP.
The fact is that till Jan18, the MPC was not able to read the risks - the current account deficit crossed billion dollar mark in Dec16 and the monthly average stood at $1.2 billion between Dec16-Dec17; but SBP was not proactive to manage the imported demand by increasing the interest rates.
The first rate hike was 25 bps in Jan18, at that point the stability was being challenged with indication of positive output gap (means demand exceeds supply), according to MPC minutes, to justify a rate hike. This was starkly different from Nov17 minutes and statement, and again in Mar18, the excess supply capacity to absorb demand was used as a rationale for no change.
How can macroeconomic fundamentals swing from one pole to the other and back in a matter of four months? How can the economy move from demand exceeding supply to excess supply to meet growing demand in two months? It seems like monetary policy decisions were premeditated and statements tailored accordingly.
The government needs to learn by having less political interference in monetary policy decisions and concurrently work on building capacity of the committee by having best and strong people at the helm.

Copyright Business Recorder, 2019

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