THE central bank thinks it is time to let ongoing economic recovery grow stronger even if it means no immediate easing in inflation. But it keeps reassuring the nation it will act responsibly if inflation goes further up.

On July 27, the State Bank of Pakistan (SBP) announced to keep its policy rate unchanged at 7pc — the level where it has been since the end of June 2020. The purpose? “The Monetary Policy Committee (MPC) felt that the uncertainty created by the ongoing fourth Covid wave in Pakistan and the global spread of new variants warrants a continued emphasis on supporting recovery through an accommodative monetary policy.”

The central bank’s press release issued after the MPC meeting listed almost all major gains the economy has made in the past year including 3.9 per cent growth, a strong revival of industrial output and improvements in the external sector including a massive reduction in the current account deficit. It also expressed hope that the current accommodative monetary policy will help sustain these gains. The central bank opined that budget 2021-22 was “broadly inflation-neutral” adding that “recent price pressures are largely supply-driven and transient.”

For the time being, continuing with an accommodative monetary policy seems to be the only choice

This assertion is, however, arguable. The very fact that a strong economic recovery is continuing makes a different assessment more plausible. That is, ongoing inflationary pressures are demand-driven, at least partly. What lends credence to this view is the fact that as recently as in June, even non-food inflation for urban and rural Pakistan was higher than in May.

In May, non-food inflation stood at 5.4pc and 7.1pc in urban and rural areas but in June it rose to 5.7pc and 7.4pc respectively. The “largely supply-driven and transient” price pressures were perhaps reflected in food inflation readings in June — down to 12.4pc for urban areas from 12.6pc in May and to 13.1pc for rural areas from 13.6pc in May. Technically, food inflation should reflect supply-driven and transient price pressures more than non-food inflation does because of the price inelasticity of demand for most food items.

Regardless of this debate, the SBP has rightly identified some factors that may add to existing inflationary pressures during this fiscal year like higher than expected global commodity prices — especially if these are coupled with upward adjustments in PDL (petroleum development levy) —or domestic energy tariffs as well as fiscal slippages that lead to stronger demand-side pressures through the year. And, it has once again reassured the nation that “the MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability and growth — and will be prepared to respond appropriately, as and when required.”

This statement is very important. It essentially indicates the willingness of the central bank to help the government achieve a higher economic growth target of 4.8pc this year, up from 3.9pc in the last year. Careful monitoring of “the developments affecting medium-term prospects for inflation, financial stability and growth” would naturally help the SBP shape its response to short-term inflationary pressures in a way that does not hit financial stability or hurt economic growth prospects.

Non-food inflation rose to 7.4pc in rural areas in June

And that exactly is required in the economy at this stage. After going through a 0.5pc recession in 2019-20 and after showing a 3.9pc recovery in 2020-21, the economy needs to grow even more strongly during this year and in the next.

Otherwise, lost jobs cannot be reclaimed fully. Nor can additional jobs be created on a large scale. Nor the external sector’s worries can be mitigated through a right mix of substantially large non-debt creating forex inflows and limited debt-creating external borrowings and foreign funding.

A very measured monetary policy response to short-term inflationary pressures (gradual and limited increase in interest rates — and that too after factoring in its impact on financial stability and growth) will suit the government and businesses alike.

The opportunity cost, perhaps, will be the deepening of inflationary pressures that will be felt more by financially poor people and those segments of the population that lack skills and entrepreneurship to enhance their income levels in a period of economic recovery.

The impact of a persistent accommodative monetary policy on savings would also be felt after a while. But for the time being, continuing with an accommodative monetary policy seems to be the only choice. Reversing this stance suddenly or opting for inflation-fighting with full force is obviously not a wiser move. It is a separate story, though, that inflation may come down naturally with growth-suffocating if the Covid-19 pandemic hits us and the world harder than anticipated. In SBP’s words “the key risk that could lower inflation is a resurgence in the pandemic domestically and globally.”

No one can pray for that to happen!

Fiscal authorities should pay heed to the factors that SBP says can push inflation further up particularly fiscal slippages. There is no room for that in the present situation. They must also strengthen their capacity to check inflation via non-monetary measures like fuller enforcement of competition laws and stricter checks on hoarding, smuggling, profiteering and other unfair business practices. More importantly, they should work harder to use the fiscal room created by a long-held lax monetary policy to enhance the utilisation of the development budget for sustaining economic growth and for reclaiming jobs lost amidst pandemic and create additional jobs.

The fiscal room that an ultra-loose monetary policy has created in the shape of reduced cost of domestic debt servicing must also be used wisely for rebalancing domestic and external borrowings — and for right-balancing bank and non-bank borrowing to save the private sector from being crowded out.

For the current fiscal year, the central bank has projected economic growth to rise to 4-5pc from 3.9pc last year “and average inflation to a moderate 7-9pc.” Average inflation was 8.9pc last year “in line with the SBP’s forecast range announced in May 2020.”

Published in Dawn, The Business and Finance Weekly, August 1st, 2021