Focus reverts to stabilisation

The State Bank of Pakistan (SBP) pulled a big surprise on the market when it boosted its key policy rate last week by a lot more than anticipated by analysts to contain the soaring prices and stop the consistent decline in the rupee on a growing current account deficit.

The monetary policy decision is indicative of the fact that the government is shifting its pivot from growth again to ‘stabilisation’ by rolling back the pandemic stimulus and expansive pro-cyclical policies that it was pursuing to push growth to win over the man on the street ahead of the 2023 elections.

The SBP decision comes on the heels of an announcement from the country’s finance chief Shaukat Tarin that Islamabad had sorted out issues obstructing the resumption of the $6 billion loan facility from the International Monetary Fund (IMF), which had outlined five prior actions before its board approves the deal.

The prior actions include a passage from the parliament of the proposed amendments to the SBP Act to ‘free’ it from political influences, an increase in the electricity tariffs (which have partially been implemented while the next raise is expected in February), the introduction of measures to bolster taxes through withdrawal of income and sales tax exemptions and reduction in expenditure to achieve a primary balance this fiscal year.

The PTI government’s growth script has gone awry in just four months and now it is blaming international commodity prices for the mess it has created

The remaining conditions relate to the rollback of monetary stimulus and containment of imports by the central bank through an increase in the policy rate.

With the rupee falling to its new lows and stocks plunging on delays in the finalisation of the IMF deal, it is crucial for a cash-strapped Pakistan to revive the programme as early as possible. Therefore, we saw the central bank bring forward the monetary policy committee meeting by a week to November 19 because of what it described as “unforeseen developments that have affected the outlook for inflation and the balance of payments, and to help reduce the uncertainty about monetary settings prevailing in the market.”

Read more: Falling rupee

The bank has raised its benchmark rate by 150bps to 8.75 per cent to “stay ahead of the market as yields have already increased in the secondary market to 8.6pc”. The rate increase compares with wider market expectations in the range of 75bps-100bps. This is the second consecutive hike in its policy rate announced by the SBP.

The bank had in its September monetary policy statement jacked up the interest rate by a mere 25bps for the first time in 15 months with a view to protecting economic growth by keeping “inflation expectations anchored and slowing the growth in the current account deficit.” It has since taken multiple steps to ease domestic demand, including restricting consumer financing and raising cash reserve requirements for the banks to absorb excess liquidity from the market at the cost of slowing the economy’s recovery.

The bank sees risks to inflation and balance of payments to have increased in the last two months while the outlook for growth has continued to improve. It also sees the current account deficit for the present fiscal year to “modestly” exceed its forecast of 2pc-3pc of GDP while global commodity prices and potential further upward adjustments in administered prices of energy pose upside risks to inflation.

Hence, there is now a need to proceed faster to normalise monetary policy to counter inflationary pressures and preserve stability with growth. In its forward guidance, the bank has hinted at a further increase in the cost of credit going forward to achieve mildly positive real interest rates. Last time, it had expected the monetary policy to remain accommodative in the near term in the absence of ‘unforeseen circumstances’. It has also announced an increase in monetary policy transmission frequency from existing six reviews to eight reviews a year.

The headline consumer prices, which had spiked by 9.2pc last month, are widely anticipated to enter the double digits when the PBS publishes Consumer Price Index numbers for November. The average inflation for the entire year is also expected to remain in the double digits, well above the central bank’s 7pc-9pc target range.

Pakistan’s current account deficit has already expanded to 4.7pc of GDP to $5.1bn in the first four months of the current fiscal from a surplus of 1.4pc or $1.3bn a year ago on spiking trade deficit. The trade deficit has more than doubled to $13.8bn from $6.8bn during the period between July and October on a sharp rise in imports and global commodity prices. The trade in services gap also rose by 38pc to over $1bn from $750 million.

The increase in remittances sent by overseas Pakistanis has been slower as is the case exports with foreign direct investment flows declining to $662m from $751m, bringing pressure on debt-based forex reserves. The rupee has slumped almost 13pc since mid-May, making it the worst performer in Asia.

If anything, the last few months underline the fallacy of the growth claims made by the PTI government’s finance managers in spite of warnings that the blind pursuit of such policies without addressing deep-rooted structural issues of the economy and boosting productivity and exports would bring pressure on the weak external sector and have serious consequences.

Nonetheless, the government recklessly insisted it could achieve 4.8pc growth this year without any disruptions to the economy. But no. Its growth script has gone awry in just four months and now it is blaming international commodity prices for the mess it has created in the form of expanding current account deficit and the fastest inflation across the region as prices in Pakistan have been increasing at twice the pace in other countries like the Philippines, India, Thailand and on and on. Finalising a deal with the lender of the last resort has become crucial to ending uncertainty in the market and restoring confidence. But it will bring back more pain for the man on the street.

Published in Dawn, The Business and Finance Weekly, November 22nd, 2021