During the current fiscal year, ending in June, Pakistan’s current expenditures may end up around Rs7.7 trillion from the budget amount of Rs7.5tr, according to the Ministry of Finance’s estimates.

And, according to the mid-year budget review 2021-22, the country will see a record budget deficit equal to 5.8 per cent of its GDP calculated with the new base year of 2015-16. So, what is it — the central bank holding its interest rate at 9.75pc — a monetary lull before a fiscal storm?

If you can peel a few layers of the restrained wordings of the State Bank of Pakistan’s (SBP) latest monetary policy statement, you may conclude that a fiscal storm isn’t far away.

On March 8, the SBP announced to keep its key policy rate unchanged at 9.75pc. A press release issued by the central bank said that the monetary policy committee was of the view “that the outlook for inflation has improved.” But it went on to add that “since the Russia-Ukraine situation remains fluid”, the committee was prepared to meet before April 19, the date of the next scheduled meeting. And, if necessary, it will also take “any needed timely and calibrated action to safeguard the economy.” Well, what does it mean?

It means that in case of negative fallouts of the Russian-Ukraine military conflict on Pakistan’s economy, the SBP would not hesitate to further tighten its monetary policy — before April 19.

In case of negative fallouts of Russian-Ukraine military conflict on Pakistan’s economy, the SBP would not hesitate to further tighten its monetary policy — before April 19

The Russia-Ukraine war has sent oil prices to multi-year highs. Within two weeks of the war, the price of Brent Crude soared past $130 per barrel from $95 per barrel. And, disruptions in international trade caused by the war and consequent sanctions from the West on Russia has inflated the cost, insurance and freight (CIF) charges for shipping trade cargoes from one country to another.

So, one can expect that in the coming weeks, imported inflation will hit Pakistan’s economy. In that case, the central bank would not mind raising interest rates further — or taking any other measure — to contain domestic inflation even before April 19. And, we know that for forex-starved Pakistan imported inflation — and other negative outcomes of a probable escalation of the Russia-Ukraine military conflict like a decline in exports and foreign investment or even a disruption in remittances’ flow — might produce a fiscal storm.

A large CA deficit and the consequent imported and cost-push inflationary pressures continue to make it difficult for the central bank to contain headline inflation

Despite the fact that Pakistan’s aggregate demand is contracting somewhat, imports of fuel oil may not see much of squeezing because of ongoing strong growth in the local automobile industry. This means that the merchandise trade deficit that contracted a bit in February might start expanding from March onwards reflecting much higher global oil prices. Besides, the government has recently decided to import 200,000 tonnes of urea. Accelerated activities in the housing sector will also increase the need for imports of iron and steel and other construction materials.

Add to this the possibility of fuel oil imports for augmenting geostrategic reserves and you can have an idea of how large the trade deficit might become toward the end of the fiscal year in June. In the first eight months of the year (July 2021-Feb 2022), the goods’ trade deficit stood around $31.6 billion and looks set to reach close to $42bn— or even exceed this level — by June.

A large trade deficit continues to expand the Current Account (CA) deficit that totalled $11.6bn in seven months of 2021-22. Consequently, the rupee has lost enough strength against the US dollar. And going forward, the CA deficit remains dependent largely “on the path of the international oil prices,” as the central bank puts it in its monetary policy statement.

In less than eight and a half months of 2021-22 (between July 1, 2021, and March 9, 2022) the local currency has shed about 13.4pc value against the greenback.

This fast-paced rupee depreciation has not only been fueling inflation but has also been adding to the cost of external debt servicing in terms of local currency.

This, in turn, is bound to enlarge the fiscal deficit despite the fact that Pakistan has been able to seek some external debt rescheduling post-Covid 19.

Furthermore, fresh external debt accumulation continues to keep forex reserves falling below the level of three months of imports but new debt repayment requirements are also piling up and will put pressure on the CA in the next fiscal year. A large CA deficit and the consequent imported and cost-push inflationary pressures continue to make it difficult for the central bank to contain headline inflation. That is why, despite moderation in headline inflation from 13pc year-on-year in January to 12.2pc in February, the SBP expects it to average 9-11pc this fiscal year.

The SBP’s monetary policy statement says that “inflation in February would have been noticeably lower were it not for abnormal increases in a few perishable items.”

But that does not mean that food inflation in Pakistan remained higher in February alone. In fact, for most of this fiscal year, 220 million Pakistanis braved a prohibitively high rate of food inflation. And, it has not always been due to a rise in domestic demand. An increase in prices of agricultural inputs, fuel oil and transportation charges have contributed equally to higher food prices. In each of the eight months of 2021-22, monthly readings of the 12-month moving average food inflation ranged between 11.2pc and 12pc in urban areas and between 9.5pc and 12.2pc in rural areas, according to the Pakistan Bureau of Statistics.

Published in Dawn, The Business and Finance Weekly, March 14th, 2022