WHILE reaffirming the International Monetary Fund’s (IMF) warning that the economy may contract 1.5 per cent during this fiscal year, the State Bank of Pakistan (SBP) slashed its policy rate from 11pc to 9pc on April 16.

This was the third rate cut in a month. Earlier, on March 17 and March 24, the SBP had reduced the rate from 13.25pc to 12pc and then to 11pc. “The economy is expected to contract by -1.5pc in 2019-20 before recovering to 2pc growth in 2020-21,” warned the central bank’s statement issued after an emergency meeting of its monetary policy committee. The committee was of the view that “this action would cushion the impact of the coronavirus shock on growth and employment,” it read.

The economy is in deep trouble. Covid-19, caused by a novel coronavirus that first attacked China in January, is the culprit. It has brought economic activity to a near-standstill.

Governments around the world have come up with economic stimulus packages and central banks have slashed interest rates to prop up demand. The Pakistan government, too, has rolled out a Rs1.2 trillion stimulus package and the SBP has slashed the interest rate by 425 basis points — from 13.25pc to 9pc — in three instalments in 30 days. Both fiscal and monetary authorities want to contain the current economic downturn and set the stage for recovery in the next fiscal year.

All that matters now for the government is how to increase demand in the economy

In addition to swift monetary easing, the SBP has already taken several other measures to support the economy and combat growing joblessness.

These include “concessional financing to companies that do not lay off workers, one-year extension in principal payments, doubling of the period for the rescheduling of loans from 90 to 180 days and concessional financing for hospitals and medical centres to combat the coronavirus pandemic”.

The SBP’s recent interest-rate slashing coincided with the IMF pledging $1.4 billion for Pakistan to help it meet urgent balance-of-payments requirements. The twin moves were well received by foreign exchange and stock markets. The rupee gained some strength and the stock market witnessed a bullish run.

But the spread of Covid-19 continues. The nation does not know if it has hit the peak or the worst is yet to come. There is no official prediction about when its growth curve would flatten. Uncertainty is in the air.

Amidst this environment of fear and uncertainty, the federal and provincial governments have resorted to enforcing what they call smart lockdowns. But industries and businesses would take time to adjust to lockdown restrictions, however smart they may be. Which means a quick reversal in the declining trend seen in the industrial output even before the outbreak of the pandemic cannot be expected. The output of large-scale manufacturing slumped 3pc year-on-year in the first eight months of this fiscal year, data released by the Pakistan Bureau of Statistics (PBS) shows. But the decline in February alone was much smaller — 1.15pc. Had the coronavirus not hit Pakistan, one could have expected modest growth in large-scale manufacturing at the end of the fiscal year. But the government and the SBP are still optimistic about it. That is why the federal government has eased lockdown restrictions for industries and that is why the SBP is busy making bank credit cheaper.

Lower lending rates — and the easing of lending rules, including the relief provided on the bad loans’ treatment — will likely boost private-sector credit demand. But it is yet to be seen how consumers and businesses behave in availing cheaper bank loans.

Domestic demand is too low to accelerate inflation except through short-term spikes in food prices owing to supply constraints

An equation has to be developed between the two because currently the economy is suffering owing to both depressed demand and constrained supplies. If consumer demand increases but supplies remain constrained owing to the disruption caused by the lockdowns, hopes of output growth would fade. Or if cheaper credit on easier terms boosts the output of industries but domestic demand does not pick up proportionately or exports remain constrained, that too would be unfortunate.

Between July 2019 and February, banks’ net fresh lending to private-sector businesses totalled just Rs123bn, SBP data reveals. The release of March and April statistics in due course would show how interest rate easing — three times between March 17 and April 16 — began impacting such credit flows.

Wouldn’t the pre-pandemic economy be in better shape had the SBP cut interest rates back in its January monetary policy meeting? Well, many independent economists and all business leaders were expecting that, but those were different times. The central bank was too concerned about taming double-digit inflation, global oil prices were twice what they are today and foreign exchange–starved Pakistan was relying a lot on hot money coming into high-yield treasury bills.

Times have changed now. Global oil prices have collapsed, which means the country can now hope that the resultant decline in imports can compensate the outflow of foreign investment from treasury bills. The entire world is heading towards a deep recession, which means smaller imported inflation anyway, more so if the rupee remains stable. Domestic demand is too low to accelerate inflation except through short-term spikes in food prices owing to supply constraints amidst lockdowns. So inflation is not a major concern now.

In fact, the SBP believes that yearly headline inflation (10.2pc in March) will soon come down to single digits. It did express this belief, though in eruditely guarded words, in its April 16 press release.

All that matters now for the central bank and the government is how to increase demand in the economy and get resources for financing the economic stimulus package without resorting to additional foreign borrowing. With the approval of the IMF’s $1.4bn for urgent balance-of-payments needs and with chances of external debt rollovers, Pakistan is now better placed to keep its external sector in shape, more so because policymakers also continue to introduce exports- and remittances-boosting measures. The SBP has once again offered monetary benefits to banks and foreign exchange companies for mobilising remittances. Exporters have already got lots of incentives.

Published in Dawn, The Business and Finance Weekly, April 20th, 2020