The State Bank of Pakistan (SBP) has raised its key policy rate by 100 basis points to 16 per cent to ensure that the current high rate of headline inflation (26.6pc) doesn’t become entrenched and “risks to financial stability are contained”. The central bank believes that “the short-term costs of bringing inflation down are lower than the long-term costs of allowing it to become entrenched.”

In other words, the SBP’s monetary policy committee (MPC) has taken a medium-term view of economic growth and not a short-term view. If it had allowed the interest rate to remain unchanged, that might have helped a little in economic growth, but in that case, current high inflation would have become too deep-rooted to be taken care of in future, affecting medium-term growth.

The SBP press release issued after the November 25 MPC meeting noted that amid the ongoing economic slowdown, inflation is increasingly being driven by persistent global and domestic supply shocks that are raising costs. “In turn, these supply shocks are spilling over into broader prices and wages,” implying that this contributes to headline inflation growth.

While commenting on the fiscal slippages in the first quarter of this fiscal year, the SBP said, “it is important to minimise slippages by meeting additional spending needs largely through expenditure re-allocation and foreign grants.” Reminding the government of its role in inflation-fighting, the central bank said: “maintaining fiscal discipline is needed to complement monetary tightening.”

If interest rates are left unchanged, economic growth may get a slight boost, but the high rates of inflation will become too deep-rooted to be taken care of in the future

Meanwhile, Pakistan’s foreign exchange reserves continue to fall. The $7.826 billion reserves held by the SBP (as of November 18) are not sufficient to cover merchandise imports bill of even one-and-a-half months. At the end of January this year, the SBP had $16.608bn in forex reserves that started depleting month after month and are now less than half of that.

The government says it will pay $1bn to holders of Pakistan’s international bonds when the payment becomes due on December 5. That will put all speculations about default to rest and help improve Pakistan’s credit rating. Moreover, the new army chief has been appointed and speculations surrounding this appointment are history. This should ideally help mitigate political instability and contribute to the speculation-driven part of the current forex crisis.

However, the forex crisis we face now — falling forex reserves, limited import payment capacity and constant pressure on the rupee — results from deep-rooted years-old external account issues. None of those structural issues will go away in the short term. And what are the issues? Well, to answer simply — low export growth, high import growth, reliance on remittances without giving overseas Pakistanis the right to vote, preferring hot money over foreign direct investment (FDI) and over-dependence on external borrowings.

Pakistan’s post-flood damages are huge and it rightly deserves climate justice. But will $13bn foreign flood aid come in within three years, as the government expects? Already there are ifs and buts attached to this expected financing and newer conditions may pop up in future.

The actualisation of this planned financing depends on the homework to be done by Pakistan and also on how smartly Pakistan navigates through emerging challenges of geopolitics. According to a press release of the National Assembly standing committee on foreign affairs, the country has already “received” $3.4bn cumulative forex assistance after the floods. The sum presumably includes foreign assistance pledges and loans that will take time.

Saudi Arabia is willing to set up a $10.5bn oil refinery. The government keeps telling us that the country will soon receive enough foreign exchange through the refinery project. But Saudi Aramco is reportedly seeking a 20-year tax holiday along with other concessions for the project. And even if the government agrees to offer this concession (which will have a major impact on revenue mobilisation and growth of domestic oil refineries), only 30pc of the $10.5bn or $3.15bn will come into the country as equity.

The project’s remaining 70pc ($7.5bn) will come in the form of commercial bank loans. And we should not forget the fact that such mega projects are completed in no less than five years. So, foreign funds will continue trickling in phases, not in one go.

That said, the finalisation of such a massive FDI project would undoubtedly open the doors for more foreign investment from other countries. And that would surely help Pakistan’s economy in the long run — and that, too, if the overall environment and policies become friendlier for luring foreign investors.

The reduction in the Current Account deficit during July-Oct 2022 (to $2.821bn from $5.305bn in July-Oct 2021) is an appreciable development in external sector accounts. The trend may continue throughout this fiscal year as the government and the central bank can afford to contain imports amidst low economic growth, but in the next fiscal year the situation might change.

Recently oil importing refineries have turned to the government and the central bank to help them deal with the abnormally high charges that banks now demand for confirming letters of credit due to the forex crisis.

The SBP and the Ministry of Finance are trying to find a way out for them because the country cannot afford to let imports of fuel oil drop to a level where maintenance of strategic reserves becomes too challenging.

Obviously, the solution to this single issue and all other issues related to forex shortage lies in the improved supply of foreign exchange. Time is running out for Pakistan. Unless a few billion dollars come in immediately, the forex crisis will get out of hand. Already the rupee has lost 25.7pc of its value so far this year, falling to 223.94 to a US dollar on November 25 from 178.17 to USD at the end of December 2021.

Published in Dawn, The Business and Finance Weekly, November 28th, 2022