Eversince the central bank of Pakistan began monetary tightening, our business community leaders have been criticizing the central bank for raising its key policy rate. They argue that Pakistan has one of the highest interest rates in the world, though the government claims to have planned to spur economic growth. This economic behaviour is illogical and irrational, according to them.
However, while articulating this prophecy, these critiques of tight monetary policy do not touch upon the crucial subject of mounting inflation, which is actually the mother of all economic ills. Given the severe economic imbalances that Pakistan is currently confronted with, it should now be very clearly understood that the most important and priority number-one economic problem of Pakistan is the rising inflation, which is not only hurting the common man but also further aggravating economic imbalances.
If the inflation is not checked, the economic imbalances with the government borrowing on top, will continue to cause the inflation keep rising and will crowd out private investment. Hence checking the inflation is itself very crucial for long-term growth of the economy on sound footing.
In an economy like Pakistan where real interest rate has been negative given the higher rate of inflation than nominal interest rate being offered to savers, what sound economic justification do these critiques of central bank have for rejecting the monetary tightening in the wake of this well-established notion that price stability is a prerequisite for long term economic growth and future investments on sustainable basis.
Before making negative comments on the central bank's tight monetary policy stance, we all must understand the motives the central bank has before it. As far as contorting inflation is concerned, it is beyond any doubt that price stability is a major responsibility of the central bank and it must keep focusing for ensuring price stability for the sake of long-term economic growth - a growth that may sustain for a period, sufficient to put the economy on sound footing.
The central bank of Pakistan has, for many years, been sending this nudge to our Islamabad-based policy makers that inflation in the given economic circumstances can only be contained by reducing excess money demand while encouraging income accumulation. We clearly need to understand that inflation can be controlled either by reducing excess demand or by increasing supply of goods and services. However, since the supply takes long time to expand and a number of infrastructural changes are required for this, so controlling inflation through increasing supply of goods and services is not visible in short run. Hence, the central bank is left with no option other than reducing demand for money in the economy. Besides, at the same time, our central bank needs to correct future price expectations of consumers and investors simply because if people keep expecting higher prices in future, the inflation will remain at higher side even in the case if all corrective measures are exhausted except those, which are required to correct major economic imbalances. It is an established fact that to correct the future price expectations, the economic imbalances will have to be addressed rigorously.
The critiques of SBP's tight monetary policy stance have been unable to address these concerns of monetarists in Pakistan. Hence, their argument against tight monetary policy is invalid as far as long-term growth prospects are concerned for which they argue that rising interest rates in the economy are hurting economic growth.
It appears that the critiques of tight monetary policy stance have failed to take into consideration the harms that huge printing of currency notes has been causing to overall economy. We must understand that the money creation owing to ever-increasing government borrowing from the central bank as a cheap source of funding is a main source of inflation in present states of the affairs of the country's economy. The present government has completely failed to diversify its sources of borrowing from the central bank to those other avenues that do not cause money creation.
The present government has since its inception resorted to heavy borrowing from the central bank and thus forcing the central bank to create money while depriving the majority of population of its major portion of income in real terms. The severity of this problem can be judged from the fact that the government is borrowing Rs 2 billion every day to finance its deficits.
Moreover, the inflation if not checked, will certainly further worsen the balance of payments (BoP). If the country continues to live in a high and unbearable inflation environment, our exports will fast become uncompetitive in global markets. On the other hand, the imports will definitely rise under these circumstances. As a result of this situation, the pressure on exchange rate will certainly surge.
Do the critiques of tight monetary policy stance have satisfactory response to these concerns if they really want the central bank to soften its monetary policy stance amid present economic imbalances? Yet, we have not heard them explaining their position on this. This is the need of hour that the central bank must keep focusing on correcting the economic imbalances, which will not be removed unless Islamabad complies with its policy commitments with the central bank such as limiting the government borrowing. It must be acknowledged by the Islamabad that economic imbalances are now more severe than ever.
Given the whole economic scenario and present states of affairs, it is rightly expected from the central bank of Pakistan that it will further raise its key policy rate and adopt other monetary tools to meet the daunting task of price stability in the country. No doubt, we have reached an economic impasse and the people of Pakistan now expect prudent and coherent economic decisions from Islamabad and the central bank of Pakistan.
(The writer is a student of applied economics.)