The Monetary Policy Statement (MPS) released by the Monetary Policy Committee (MPC) of the SBP on 26th November, 2016 contains no surprises. As widely expected, policy rate of the State Bank has been kept unchanged at 5.75 percent per annum for the next two months and the reasons given for the continuity of the present stance are also quite familiar. The most compelling reason was of course an uptick in inflation. After bottoming out in October, 2015, CPI inflation has been following a rising trend, with the year-on-year CPI inflation increasing from 1.6 percent in October, 2015 to 4.2 percent in October, 2016 and core inflation inching upwards as well. These movements were also partially mirrored in the IBA-SBP survey of November, 2016 that shows a moderate rise in consumer confidence and inflation expectations for the next six months. According to the MPS, "this manageable inflationary environment over the near-term bodes well for the current growth momentum." International oil price movements could, however, impact inflationary pressures. As for the money market, volatility in the interbank market remained low and overnight money market repo rate stayed close to the key policy rate in the post-September, 2016 monetary policy period. On the global economic front, "uncertainties exist for international financial markets and world trade amid anticipated interest rate hike by the US-Fed" while global growth outlook for the world economy was mixed for 2016.
The MPS is quite optimistic about external sector developments. It says that continuous build-up of external buffers over the last three years has improved country's resilience against external uncertainties. This was reflected in the current level of foreign exchange reserves which are sufficient to cover more than four months of import payments. Recent improvement in Pakistan's credit rating along with official financial inflows was projected to sustain foreign exchange reserves. However, unpredictability of non-trade flows would influence the current account balance during the rest of FY17.
In a situation narrated above, no central bank was expected to take a casual approach or ease its monetary policy stance because such a strategy would exacerbate the current trends in macro-indicators sought to be stabilised. In fact, there was no possibility of such a policy option at this juncture. The most important objectives of monetary policy are ensuring price stability and a sustainable position in the balance of payments together with securing growth prospects of the economy by maintaining adequate flow of credit to the private sector. Unfortunately, however, price pressures in the economy seem to have re-emerged and the current account deficit of the country is widening to almost unsustainable levels. CPI inflation during 2015-16 was down to only 2.81 percent but has been rising during the current fiscal year. According to the latest estimates of the SBP, the rise in CPI could be more than double compared to the previous year as against the target of 6.0 percent this year. The price situation could worsen if the oil prices in the international market do not continue to be depressed and the exchange rate of the rupee comes under pressure. During the last few weeks, the rupee rate in the open market has already depreciated to around Rs 107 to a dollar and if this trend continues, interbank rate of the rupee could also deteriorate correspondingly, pushing up the inflation rate further. The external sector outlook is also a cause of concern. Both the trade and current account deficits of the country are widening with the passage of time. The key factors determining the outcome in the external sector like export receipts, home remittances and direct foreign investment have worsened a great deal during the current fiscal and there is no possibility of improvement in these areas in the near future. Yes, the flows of foreign investment may stabilise somewhat but it is likely to be only on account of inflows from China on account of CPEC as investors from other countries do not seem to be much interested. Another problem is the re-emergence of conservative groups and governments in the US and some of the EU countries which could adversely impact the flow of resources to developing countries like Pakistan. The possibility of a US rate hike is another issue which could encourage flows of funds to the US and undermine our external sector outlook. Yes, the present level of foreign exchange reserves held by the SBP is quite comfortable (equal to about four months of import requirements) but we should not always be exulting about them, particularly when a large part of reserves is due to foreign loans from various sources which have to be repaid with interest and most of the other countries have the luxury of having much higher levels of reserves but do not boast about them. No mention in the MPS has, however, been made about external loans through euro-bonds or banking channels which has taken away some of the shine of buoyancy in the external sector. Seen objectively, the SBP was justified in increasing the policy rate by a thin margin of 0.25 percent or so but it was also not a bad idea to wait for sometime more to observe the unfolding of developments before making the next move. After all, it is the responsibility of the SBP to fulfil its desired objectives in a way it thinks fit. Moreover, it is its prerogative to determine the timing of available options. We, however, wish that its decisions are not guided by Islamabad or some other stakeholders but are made purely on the merit of the obtaining situation.
Pakistan needs to consider its external account vulnerabilities while fixing the policy rate. How long can we stick to the present parity when all other currencies have depreciated by nearly 10 percent against the dollar? This needs an answer. The government must not lose sight of the fact that it needs to make the country attractive for foreign investment. After all, we are a sizeable market.