The State Bank of Pakistan’s (SBP) decision to keep its policy rate unchanged at the June 2020 level of seven per cent throughout this fiscal year has been a key driver of an estimated 4pc economic growth.

On May 28, the central bank announced that it would keep the rate unchanged for another two months ending in July, the first month of the next fiscal year. It also reiterated that any upward adjustment in interest rates in the future would be “measured” and “gradual”.

This is good news for the government and the (non-bank) corporate sector alike. Even banks don’t have much to worry about. They may continue making huge profits by investing heavily in government debt papers and extending big loans to the private sector as credit demand is rising.

Thanks to low interest rates, the private-sector credit offtake shot up about 42pc in 10 months and one week of this fiscal year as opposed to the year-ago period, data shows. Chances are that the credit offtake will remain strong till the end of the fiscal year on June 30 as private-sector credit retirement does not traditionally take place before the start of the new fiscal year.

Between July 1, 2020 and May 7, banks made net fresh lending of Rs421 billion to the private sector against that of Rs297bn in the year-ago period.

Higher bank borrowing by the government at low interest rates has enabled it to cut the cost of domestic debt and keep the fiscal deficit in check

This helped in taking the economy out of the last fiscal year’s slump and putting it on the path of a strong recovery. Latest government estimates show Pakistan’s GDP had contracted by 0.47pc last year, but has grown by an estimated 3.94pc during this year.

Low interest rates also enabled the federal government to borrow from commercial banks a huge sum of Rs2.27 trillion in 10 months and a week of this fiscal year, partly to retire the central bank’s loans. In the same period of the last year, it had borrowed Rs1.9tr.

Higher government bank borrowing at low interest rates has enabled it to cut the cost of domestic debt and that has helped it in keeping the fiscal deficit in the first nine months of this fiscal year lower than a year ago. The higher intake of low-cost funds by the private sector has strongly revived the output of the industrial sector, energising agriculture and revitalising the services sector. Last year’s low base and the Covid-19 triggered dynamics of domestic trade also had a hand in the recovery in industrial and services sectors.

The government hopes that the recent economic recovery can further solidify in the next fiscal year. The SBP, in its May 28 monetary policy statement, also insisted that “The current significantly accommodative stance of monetary policy remains appropriate to ensure the economic recovery becomes firmly entrenched and self-sustaining.”

In plainer words, the central bank made it clear that it too was supporting the government in its effort to solidify this fiscal year’s economic gains into the next year. This, however, does not mean the SBP remains oblivious to its primary responsibility, which is ensuring price stability.

The SBP has advised the government to check food inflation through administrative measures as it believes that the future headline inflation rate will be affected by food and energy prices.

In its monetary policy statement, the SBP linked the current high headline inflation to “supply shocks to food and energy, including the lingering impact of February’s electricity tariff hikes.” The national average yearly headline inflation in April stood at 11.1pc and food inflation in urban and rural areas was measured at 15.7pc and 14.1pc, respectively.

Managing food inflation entirely via administrative measures does not seem appropriate

The monetary policy committee of the central bank said that second-round effects of the prevailing supply shocks to inflation are not manifest at the moment. But it warned that “as the economy gathers further momentum, it will be important to ensure that food price pressures are reversed through successful implementation of the administrative measures to keep second-round effects in check”.

But leaving food inflation management entirely to the administrative measures does not seem appropriate. And the assumption that higher food inflation is just a product of “supply shocks” — isolated from the overall inflationary pressure in the economy — remains a moot point.

A week before the latest monetary policy committee meeting, the SBP announced the beginning of the release of an advance calendar for such meetings with exact dates of next

four meetings. So the latest monetary policy statement is the very first after the decision regarding the advance release of the aforesaid calendar — a process that the SBP says should make the policy formulation “more predictable and transparent”.

This exercise — along with the SBP’s Jan 2021 decision of providing forward guidance to the economic agents on monetary policy — and its repeated assurances that any shift in the current accommodative monetary policy stance would be measured and gradual — should be helpful in keeping inflationary expectations anchored around a certain level. The SBP says overall inflation may remain close to 9pc for this fiscal year. But it also notes that “as supply shocks dissipate thereafter, inflation is expected to gradually fall toward the 5-7pc target range over the medium term.”

This clearly implies that the central bank will be chasing in coming years an inflation target of 5-7pc and would naturally begin tightening interest rates when circumstances demand. For the time being, the government and large businesses that are the main beneficiaries of low interest rates should thank the SBP.

A large number of small and medium enterprises (SMEs) — barring a few hundreds — and most consumer loan seekers have benefited little from the interest rate slashing in the past one year. But more on that later on.

Published in Dawn, The Business and Finance Weekly, May 31st, 2021