In six and a half months of this fiscal year, growth in reserves money (RM), a sure indicator of inflationary buildup, remained higher than in the last year. This means inflation during this fiscal year will be higher than in the last year, despite all the fiscal and monetary tightening we have seen so far. Between July 1 and Jan 14 2021-22, RM grew 2.79 per cent against 1.19pc in the year-ago period, according to the State Bank of Pakistan’s (SBP) data. The SBP indicated in its latest monetary policy statement that inflation during this fiscal year would remain close to 11pc against 8.9pc in the last year.

With the beginning of the new fiscal year in July, one can hope for easing inflation (and slower growth in RM will be a sign of it), thanks to the demand-dampening mini-budget approved recently by the Parliament and monetary tightening by the SBP.

The SBP believes that the demand side inflationary pressures are already waning faster after the recent fiscal measures validated through Finance (Supplementary) Act— “and recent moderation in economic activity indicators.”

The most glaring example of this moderation is the decline in large-scale manufacturing (LSM). Year-on-year LSM output growth tanked to 0.3pc in November 2021 from 13.8pc in November 2020.

LSM production in July-Nov 2021-22 also slumped to 3.26pc from 6.85pc in July-Nov FY21, according to the latest update of the Pakistan Bureau of Statistics.

The aggressive 250bps rise in interest rates announced in less than a month is sure to dampen domestic demand and imported inflation — these factors put together may keep inflation closer to the upper end of the revised inflation range of 9-11pc

On Jan 24, the SBP decided to keep the interest rate on hold at 9.75pc till the review of its monetary policy due on March 8. The central bank said its decision was “in line with the forward guidance provided in the last monetary policy.”

So, what was that “forward guidance” by the way?

While hiking its key policy rate from 8.75pc to 9.75pc on Dec 14, the SBP had stated that “due to recent higher than expected outturns,” it expects inflation to average 9-11pc this fiscal year.

Now, keeping its policy rate unchanged the central bank has signalled to the markets that keeping inflation within 9-11pc does not require further monetary tightening at this stage. The SBP’s monetary policy committee is scheduled to meet again on March 8 to review its policy.

In October last year, national average consumer inflation had risen to 9.2pc year-on-year — breaching the central bank’s previous forward guidance estimate of 7-9pc. This happened despite a nominal increase of 25 basis points in the central banks’ policy rate — from 7pc to 7.25pc announced on September 19. Growing aggregate demand — supported by the government’s fiscal stimuli and the central bank’s own post-Covid economic support credit programmes — easily swallowed this moderate hike in the interest rate. And, year-on-year inflation first rose to 11.5pc in November and then to 12.3pc in December.

Between Nov-Dec the SBP administered a double dose of monetary tightening to the economy — taking its policy rate from 7.25pc to 8.75pc on Nov 19 and then to 9.75pc on Dec 14.

This aggressive 250bps rise in interest rates announced in less than a month is sure to dampen domestic demand thereby affecting the demand-pull part of inflation and is also capable of decelerating demand for imported goods thus containing imported inflation. Going forward these two factors, put together, may keep inflation “closer to the upper end” of the revised forward guidance range of 9-11pc, according to the SBP’s monetary policy statement. This is why the interest rate remains on hold for the time being.

What led the SBP to form the view that containing inflation in this range is now possible is that monetary policy tightening has happened alongside imposition of higher cash reserves requirement (CRR) for banks), regulatory tightening of consumer finance, and curtailment of non-essential imports.

On Nov 13, just six days before 19th Nov’s huge interest rate hike of 150bps, the SBP had raised CRR for banks (to maintain for two weeks) from 5pc to 6pc and from 3pc to 4pc to maintain each day. But what diluted the impact of this measure on a net basis was that the central bank continued injecting huge funds into the interbank money market to keep them liquid enough ahead of the scheduled auctions of the government treasury bills and bonds. Earlier on Sept 23, just four days after a nominal interest rate hike of only 25bps, the SBP had made the rules stricter for banks in regard to offering auto finance, personal loans. It was an important step and could have led to a real dampening of domestic demand had it come alongside a sharper increase in the interest rate.

How effectively the measures are taken for curtailment of non-essential imports may contribute to the easing of inflation should become evident, at least partly within this fiscal year. The effectiveness of these measures — the imposition of higher regulatory/import duties and increased general sales tax as well as the requirement of high cash margins at the time of opening of letters of credit — cannot be denied.

But the key question is: wouldn’t their net effect be largely mitigated if international oil prices remain high, if refineries continue to import more of refined petroleum products rather than crude oil, if gas shortages persist requiring more of natural gas imports — and if food imports bill continue to swell on higher global prices of food commodities and stubbornly high domestic demand? We must not forget that demand for various imported food items remains inelastic to prices.

Published in Dawn, The Business and Finance Weekly, January 31st, 2022