Interest-ing

Let me begin with a bit of reverse bragging; I am not a foreseer, so don't believe everything that appears in this column; the sole objective here is to make people think. Well at least those of us who have time to read, which is not very many since reading is not an extremely popular pastime now a days; and as more time passes, my guess is people who continue to read will attain legendary status.
The prediction, a couple of weeks ago, that Pakistan will pretty soon have a new finance team, after the change at the top, was a logical construct; and let's all hope that the other rational conclusion in the same article turns out to be very much wrong as time passes. Except, unfortunately, IMF and its programs for the developing world, are rather predictable; nothing good has come out of them historically, at least for Pakistan! That Pakistan has approached IMF more than a dozen times is perhaps more a reflection on IMF and its ability to devise a program which fosters economic stability, than against Pakistan!
Nonetheless, we will soon have a new money boss; most likely he/she will probably already be in the driving seat by the time this write up is published. Rumour has it that the current boss was asked to leave, which perhaps raises doubts on the autonomy of the Central Bank and the monetary policy. But frankly who cares whether the central bank is autonomous or not; albeit, on the other hand, the government might, if it is genuine autonomy, and the Central Bank decides to curtail lending to the State.
Ignoring autonomy, most of us still haven't figured out what does the central bank do in the first place and none of us have a clue about the monetary policy. No, the central bank does not have a huge printing press in the basement to print currency, and no, it does not have tons of gold in the lower basement. Commercial banks create money and what little gold we have in the reserves really does not require a lower basement. And those who tell you they know what the Central Bank does, think they do but they probably don't!
Central bank autonomy became a fad in the Western world around the late 90s, and their central banks took on the responsibility of targeting inflation at around 2% somewhere in the beginning of the 21st century; my history may be slightly off here but that is not the point. According to the Taylor Rule, "interest rates should rise if inflation is above its target and output is above its trend level and fall when the converse is true"; and this is how central banks supposedly target inflation. The point really is, if our central bank is autonomous, why does the government get blamed for inflation, and what exactly is the inflation target rate that the central bank believes is appropriate for Pakistan; because without a target how does it determine interest rates in the first place. And can we even determine if output is above its trend level?!
A few weeks ago, this column inquired what is the ultimate balance vis-à-vis interest rates for Pakistan, in light of economic theory and what was heard on the grapevine. Rumour has it that interest rates were kept artificially low by the previous government so that government's cost of debt servicing, and hence the fiscal deficit, stayed within manageable levels; government being by far the largest borrower in Pakistan. Further significant outflows from foreign currency reserves kept the rupee stable, apparently in pursuit of the same objective; an analysis of the cost of managing the rupee during this period may bring to fore some interesting insights. The fact that low interest rates encouraged households to bring forward spending from the future to the present, fuelling consumption, which rather than galvanizing domestic demand, mostly because of a stronger rupee, further increased the trade deficit, was probably viewed as collateral damage and hence ignored. Consequently, external debt went up significantly, and so did domestic debt; but since nobody understands interest rates anyway, there wasn't any notable hue and cry.
During the last year or so, the policy rate was almost doubled, and frankly, at least in my opinion, the Central Bank could not defend the rupee, which therefore depreciated significantly as a consequence. And while the increase in the policy rate had a happy impact on the real interest rates, rate of interest less inflation, inflation seems to be moving ahead unchecked, which by the way might also have to do with a weaker rupee and the nation's continued obsession with consumption. There is also a view that in the presence of a very large black economy, cash economy to use a politer term, interest rates really have a marginal impact on inflation. All this strengthens my view that economics does not have any single optimising solution for each problem in the real world.
The question then therefore still remains: if interest rates may or may not impact inflation, irrespective that the target inflation rate has either not been set or is a carefully guarded secret, and the rupee is by and large defenceless, what exactly will the central bank now do, even if we figure out what it does in the first place. Personally, I do hope they update the data on their website, since it still shows the debt figures for 31 December 2018; for the record Pakistan's total debt and liabilities as at 31 December 2018 stand at Rs 33,238.8 billion. And the external debt and liabilities, included in total debt, at that date stood at USD 99.1 billion. Anybody's guess where they stand at today!
And what if the central bank allows the Rupee to float freely in the market?
Best of luck to the new money boss; the job if not full of mystique, is surely interest-ing!
(The writer is a chartered accountant based in Islamabad. Email: [email protected])