Price stability contributes to financial stability. Financial stability helps banks price and reprice loans easily and enable them to increase the volume of private-sector credit for economic growth.

Banks always add inflation-risk premiums while pricing and repricing their loans. But once a country starts inflation targeting, once the central bank shares a medium-term inflation outlook and makes meeting the inflation target the only objective of its monetary policy, inflation-risk premiums can be minimised or even eliminated from loan pricing. And that, in turn, can help boost private-sector credit.

In Pakistan, private-sector credit remains as low as 18.1 per cent of GDP against 50.2pc in India and 45.3pc in Bangladesh, according to the World Bank. Obviously, there is an immediate need for enabling banks to lend more generously to the private sector.

Inflation targeting, due to start from the next fiscal year, may be helpful in this regard.

Price stability — or inflation oscillating in a narrow band suitable for an economy — is the ultimate objective of inflation targeting. It also helps economic managers make realistic financial projections of long-term projects necessary for development. Above all, it helps in more realistic wage-setting both in public and private sectors and keeps inflationary expectations in check.

It is naïve to hope the SBP will maintain its low policy rate of 7pc July onwards

But price stability does not come the easy way. Its evolution starts with greater fiscal discipline and forward-looking interest and exchange rate policies free from political influence.

Regardless of how much additional autonomy the State Bank of Pakistan (SBP) gets in the near future, one thing is clear. From next fiscal year, it will be able to move towards inflation targeting. The IMF, the SBP and the government have agreed on it. And, once the draft law for making the SBP more autonomous is tabled in parliament, even the opposition parties are least likely to specifically challenge the proposed inflation targeting. Other clauses of the draft of SBP Amendment Bill 2021 dealing with the abolition of the Fiscal and Monetary Policy Coordination Board could be challenged though.

Besides, the autonomy sought for the SBP through the proposed bill could be granted to it initially through a presidential ordinance if its early approval from parliament becomes too difficult. The IMF Board has very recently reactivated its $6 billion lending programme (that remained stalled for over a year) after Pakistan agreed to further increase energy prices, withdraw tax exemptions worth Rs140bn and give the SBP “unprecedented autonomy”.

So inflation targeting is going to start. And one can expect gradual monetary tightening to begin from next fiscal year. The next monetary policy of the SBP is due in the third or fourth week of May. But it is too early to expect that interest rate tightening will start as early as in May. In its recent monetary policy, the central bank said GDP growth can touch 3pc during this fiscal year against the initial target of 2.1pc. Any monetary tightening before July can obviously disturb this projection. The SBP, whose interest rate easing has played a key role in a faster-than-expected economic revival, cannot afford it. The central bank can afford to do this only when its monetary policies will no longer be required to aim at supporting economic growth alongside ensuring price stability. And it will likely get that freedom from the beginning of next fiscal year.

It would be naïve to hope that even after getting the required legal room for inflation targeting, the SBP would maintain its low policy rate of 7pc in July. It is unlikely because headline inflation during this fiscal year is expected to remain close to growth-killing 9pc — a possibility that the SBP has already hinted at in its monetary policy statement on March 19. According to a 2020 SBP study, inflation above 9pc in Pakistan affects negatively on economic growth.

The energy prices will be increased by 30% in next 27 months

The central bank lowered its policy rate from 13.25pc to just 7pc in five phases within 100 days (between March 18 and June 26 last year) to avoid an economic meltdown in the wake of Covid-19. Since then, the rate remains unchanged largely to support economic revival — and even amidst current stubborn inflationary pressures.

Looking ahead, “this year’s upcoming round of wage negotiations, next year’s budget, and the path of domestic energy prices and international commodity prices may have an important bearing on the inflation trajectory,” the SBP warned in its latest monetary policy statement.

Energy prices are set to rise next month. Pakistan has assured the IMF to make six upward adjustments in power tariffs between April and October this year. This assurance is part of a broader understanding that energy prices will be increased by a whopping 36pc in next 27 months — between April 2021 and June 2023 — to mobilise Rs884bn to reduce the circular debt. The proposed hike in energy prices will surely add to the inflationary pressures in the economy.

“The MPC (Monetary Policy Committee) will monitor these developments and react to them appropriately when needed,” it asserted.

In plainer words, the MPC statement warns of a further possible uptick in inflation and reassures that the SBP will go for monetary tightening when it concludes from available evidence that it should.

That is a big assurance held out to financial markets as part of the SBP’s policy of providing “forward guidance to facilitate policy predictability and decision-making by economic agents.” It was during the Jan 22 meeting of the MPC that it agreed to provide such forward guidance. First such forward guidance issued the same day stated that “In the absence of unforeseen developments, it (MPC) expects monetary policy settings to remain unchanged in the near term.” But this statement came before Pakistan lent a firm assurance to the IMF to raise energy prices and withdraw tax exemptions.

Published in Dawn, The Business and Finance Weekly, March 29th, 2021