Expectations are changing every day. Central banks across the globe are cutting rates. Pundits in Pakistan are pressurizing SBP to do the same by having an aggressive cut policy. Some say that SBP might not do in fear of hot money evaporation. Others are saying, we should negotiate with the IMF. But one needs to closely evaluate the merits and demerits of high rate cut its impact on inflation and to introspect on the external account implication of high rate regime.
One must not forget that COVID-19 is a health crisis which is triggering economic crisis and creating physiological panic. This has to addressed by health experts, not by economists or central banks. How can monetary and fiscal stimulus in developed world generate demand when people are not willing to spend for non-economic reasons. Stimulus might be more of optics and is done by those countries who can afford. What stimulus Pakistan government can give whose machinery is running on incremental debt? If any funds are to be diverted that should be for better healthcare.
Monetary policy tightening in Pakistan has brought external account stability. The stock market recent boom was triggered by external account recovery. People have short memories; but they should not be blindsided by short term gains. The argument presented for higher rate cut is oil import bill savings of $5 billion per year (if oil prices remain in vicinity of $30-35/barrel), and lower inflation due to falling oil and other commodity prices.
What about the inflation outlook if any commodity supply shock surfaces? What if there is ban on commodity exports from countries, Pakistan imports? Palm oil and pulses are two essential commodities Pakistan import. Raw material for various industries are imported. There is no guarantee that inflation will remain tamed in this crisis, especially in a country like Pakistan where hoarding in crisis in a norm.
On external front, how can one be sure on the benefits? It is not simply savings on imports one should be upbeat about. There could be significant dent in exports. The way Europe is locking down and North America is getting in panic mood, Pakistan textile and other goods exports may hamper. People can postpone non-essential buying. Major brands are already showing signs of lowering orders. Existing shipments may not be picked from ports. With slowdown in Middle East, remittances can be adversely impacted too. One cannot be sure on quantum of current account savings.
The other factor for external account stability is sustainable foreign flows in terms of debt and investment. The global bonds markets are on a freeze. Pakistan may not get half decent response if the authorities go for a bond issue now. People may like it or not, hot money was one avenue that has worked in the past few months for external account improvement. Over a billion dollar is gone. How much anyone can brag about the remaining $2 billion?
The issue in hand is how to move up the level on reserves. Probably there was an unsaid target of having SBP reserves of $20 billion and zero off balance sheet liability before really opening up the economy. As of March 6th, the reserves were $12.8 billion and about $3.5 billion off balance sheet labilities. Nearly $800 million was lost in one week. The funding sources are drying down. The utmost need is to look for fresh avenues. The government should go to IMF and WB for concessional funding in days of crisis.
Can domestic rate cut provide external funding? Simple answer is no. Even at some stage, it can create demand of foreign currency amongst local. This was happening prior to July 2019. Only a combination of rate increase and currency depreciation could bring domestic investors’ trust back in PKR. The SBP should not risk undoing it by aggressive rate cut.
The question is why a rate cut is necessary or on a broader note why globally authorities are providing stimuli. One-word answer is liquidity. The supply chains are disrupted. Manufacturing is going down. Businesses are slowing down and employment is being lost. The SBP should try to address liquidity constraints, the exporters, SMEs and big firms are facing.
Since Pakistan economy is not highly leveraged, the liquidity problems are ought to be low. There is no panic in consumer finance as mortgage is close to nil. Businesses having liquidity crunch should be dealt with in an innovate way.
The SBP has called a media briefing prior to policy announcement to explain the policy statement, today. Such things happen in the world, but unusual for Pakistan. There is an unusual meeting of banks’ presidents Wednesday morning. This is not normal either. One may speculate that there could be something different in MPS.
It cannot be an aggressive cut. Expect the cut to be 50 -100 bps (in line with CFA Society survey). There could be something on treatment of NPLs. There could be reduction in cash requirements of banks to ease liquidity pressure. There could be enhancement in exports, agriculture and SME credit limits at lower premiums.