Pak. Economy: Cautious monetary policy in an uncertain environment

Almost 550 basis points have been already added to the discount rate in a 
period of 18 months. The rationale on the basis of which these points were added were there, although, with lower intensity, but the tolerance level of the 
economy was not such which can afford another addition to the current discount rate

The most optimistic expectation of the Monetary Policy Statement (MPS) issued in the end of January 2009 was keeping the discount rate unchanged at its current level of 15 per cent. Almost 550 basis points have been already added to the discount rate in a period of 18 months. The rationale on the basis of which these points were added were there, although, with lower intensity, but the tolerance level of the economy was not such which can afford another addition to the current discount rate.

The linchpins of the MPS are as if all the problems have not yet been solved, but “Pakistan’s economy has started to show signs of the beginning to an end of a year long period of mounting difficulties and challenges.” The economy is bestowed with a favour from the heavens in the shape of global commodity and oil price crashes, as well as expected good harvest of wheat and rice. There are now signs of improvement in the outlook for some important economic variables such as inflation, foreign exchange reserves, import growth, FDI inflows and exchange rate. According to MPS, there are certain reasons underlying these positive developments.

Pakistan’s commitment under the IMF program with a Stand-By Arrangement (SBA) to hike the policy rate in order to curb demand pressures has been addressed in November 2008 by upward adjustment of 150 basis points. Other commitments include frequent and timely adjustments in the policy interest rate, rationalisation/ elimination of subsidies, market driven adjustment in exchange rate, noticeable decline in the volume of government borrowings from the SBP for budgetary support are also helpful in improving overall economic landscape of the country. Most promising exogenous factor which helped easing of demand for imports pressure was a sharp slump in the international oil prices beyond national and international expectations.

The intensity of risks and vulnerabilities which were confronting the economy during 2008 has moderated to certain extent. These risks and vulnerabilities have compelled the SBP for monetary tightening. The SBP enumerated these gains, however, the MPS is still weary of certain risks and challenges which has potential to confront the economy, and thus think that it would be imprudent to lower the guard at this stage. The deepening of the financial crisis has already started aggravating the global recession which could increase risk aversion among international investors and expatriate Pakistanis and thus resulting in the slow down of workers’ remittances and other inflows.

The government has shown great resolve on the fiscal side, and monetisation of fiscal deficit has been stopped. The fiscal deficit target for the first half is well in control but still fears are there that fiscal revenues may also jeopardise the fiscal targets in the wake of slow economic activity. The economic stabilisation program by the government has not yet implemented in letter nor spirit and certain measures suggested in the stabilisation program still need to be implemented to put the economy on a sustainable path of development.

The SBP takes incredibly high inflation in excess to 20 per cent very seriously and though the inflation rate has eased somewhat, its persistence at a high rate remains a source of great concern. The SBP is worried about persistence of a sustained period of high inflation for a long period of time because there is always a chance that inflation may take a chronic form. The will of the SBP and government to credibly commit and follow through the stabilisation program and tackle the structural weaknesses would play an essential role to fight this tendency. At a time when the full impact of demand and liquidity management measures taken by the SBP during 2008 have yet to materialise”.

In order to dissipate demand pressures and in view of the average CPI inflation of about 20 per cent for 2008-09, it was important to continue with the current tight monetary stance and keep the policy discount rate unchanged at 15 per cent. Other modes of monetary easing like adjustment in CRR and SLR was not even discussed in the MPS. The SBP is working against the tide of monetary easing and stimulus all around the world because our precarious condition of fiscal and current accounts are totally in contrast with the rest of the world. Being different in economic fundamentals also warrants different prescription for economic ills.

The SBP has taken a significant fall in the wholesale price inflation from 35.7 per cent in August, 2008 to 17.6 per cent in December, 2008 as a leading indicator of a fall in CPI inflation in the coming months. The WPI responds to inflationary developments more quickly than the WPI because the consumer market prices are stickier than the WPI. The SBP has admitted that the declining trend in inflation would gain momentum in the second half of FY09, and CPI inflation was expected to come down to around 12 per cent by end-June, 2009. However, the average headline inflation for the FY09 will still be around 20 per cent. This provides enough excuse to carry on with tight monetary policy stance for another six months.

The SBP stick to its earlier claim that the interest rate is just one element of cost of doing business with just less than 10 per cent of the entire cost in the most interest sensitive businesses. Therefore, linking poor growth in manufacturing sector would be misleading because the main culprit is none other than acute energy shortages. The real interest rate is still huge negative and the Central Banks around the world are concerned about real rate of interest rather than nominal rate of interest. The current level of monetisation could not provide any evidence of strong correlation between interest rate and economic activity in Pakistan.

The stability of exchange rate and comfortably place foreign exchange reserves provide yet another excuse for monetary easing. The foreign exchange inflows on account of buoyant growth in the FDI and worker’s remittances in the month of November and December provide ample optimism, however, the vulnerability coming from falling exports and likely cautious posture from investors in the months to come provide the SBP for over cautious approach.  

The confirmation by the State Bank that the economy is showing some improvement in certain key areas would please economic managers even though the statement is too optimistic especially when the issue of the governance has become too crucial. The basic ingredients for economic growth like energy and agriculture inputs are poorly managed. Two key sectors of the economy are badly missing lifeline i.e. the industry is short of energy and agriculture is short of fertiliser. However, this statement may comfort large majority of the people who were listening from analysts about meltdown and the insolvency threats.

Things have definitely improving but economy is still poorly managed. The fiscal adjustment through not releasing funds for development projects could not sustain for long under political government. Sooner or later the political compulsions will force the Ministry of Finance to release allocated funds. There is a need to revisit and review development projects priority. The current resolve of the fiscal authorities is commendable but we need to sustain it for longer period of time. That’s the reason the SBP has adopted very cautious approach about brushing aside all pressures for lowering the interest rates.

Pakistan’s economy is currently passing through a phase of stabilisation where a tight monetary policy stance coincided with a tight fiscal policy at a time when the world is moving towards stimulus of all kinds to provide impetus to the economic activity. The policy makers have to decide whether stimulus without stability is a viable option or not? This is because Pakistan is in need of an economy which wants better management rather than stimulus.

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