IN the Sept 21 monetary policy review, the State Bank of Pakistan (SBP) kept the policy rate unchanged at seven per cent and predicted 7-9pc average consumer inflation for this fiscal year.

The move was in line with the market expectation. After the outbreak of Covid-19 in Pakistan, the central bank cut the policy rate from 13.25pc to 7pc in less than 100 days — between March 18 and June 26. It also rolled out a series of concessional finance schemes for industries, businesses and individual bank borrowers. “Together, these monetary measures have injected an estimated Rs1.58 trillion, or about 3.8pc of GDP, in the cash flow of businesses and households,” according to a press release by the SBP.

This huge fund injection is aimed at steering the economy out of the crisis. According to the government’s estimate, Pakistan’s GDP fell 0.4pc in the last fiscal year. But the International Monetary Fund (IMF) and the World Bank estimate a much sharper decline of above 2pc. The federal government’s post–Covid-19 Ehsaas emergency cash disbursement to the poor and the jobless, concessional and incentivised commodity financing, risk-sharing facility for SMEs and accelerated tax refunds are also helping in economic recovery.

By keeping the policy rate unchanged at 7pc and forecasting 7-9pc average inflation, the SBP has signalled that zero or below-zero real interest rate must eventually come to an end. Had it projected inflation at 7pc (upper end), markets would logically conclude that zero real interest rate could stay to help the economy revive. But the average inflation projection at 9pc (upper end) means the central bank can go for a gradual interest rate timing within this fiscal year — if not in the next monetary policy review due in November. One thing is clear though — interest rate easing is over.

The second wave of the pandemic has already hit our European export markets, which can hit our already stagnant foreign sales

A rather desperate interest rate easing provided an opportunity to the private sector to retire its old, high-priced loans through fresh low-priced borrowing. And, it also helped the government sector make faster retirement of bank loans taken to finance commodity operations. Credit retirement by the private sector and on behalf of commodity operations mean a smaller impact on banks’ non-performing assets than what they must have feared following the outbreak of Covid-19.

Between July 1 and Sept 21, the net commodity financing credit retirement shot up to Rs51.6 billion against Rs13.3bn a year ago. The private sector made net credit retirement of Rs168bn against Rs136bn last year, according to the SBP’s statistics.

Massive monetary easing led to heavy investment by banks in short-term government treasury bills. On the one hand, it helped the government cut the average cost of overall domestic borrowing. But on the other hand, it made fresh borrowing via long-term bonds a bit difficult.

The IMF has noted this with concern and wants the government to limit its borrowing through short-term bills as it could impede building a dependable yield curve. That is why the government is considering launching quarterly coupon–backed Pakistan Investment Bonds (PIBs). That is also why the government has launched rupee- and foreign currency-denominated investment certificates for overseas Pakistanis. Whereas foreign currency investment in such certificates will help improve recent gains in the external account, investment made in local currency will reduce the government’s dependence on market treasury bills.

In July-August, Pakistan posted an $805 million surplus in its current account against a deficit of $1.21bn in July-August 2019. More importantly, the country’s overall balance of payments’ deficit shrank to $248m from $1.29bn. Further consolidation in these gains is expected

as the economy starts growing. Large-scale manufacturing that had slumped 10.5pc in the last fiscal year has posted 5pc year-on-year growth in the first month of 2020-21.

The central bank said while announcing the monetary policy that economic recovery in 2020-21 “is expected to be driven mainly by manufacturing-related activities and construction, which are being supported by various financial policies from the SBP, including the temporary economic refinance facility and the government’s incentives for the housing and construction sectors”. The central bank said economic growth is projected to recover to slightly above 2pc in 2020-21 but it made it clear that “the growth outlook is subject to uncertainty”.

The SBP says the downside risks to growth include a potential second wave of Covid-19 domestic infections, a possible sharp increase in infections in the winter months of our major export markets in Europe and the United States and the threat to agriculture from locust attacks.

Pakistan is managing the Covid-19 pandemic well and can be expected to manage the second wave in an orderly manner. But the second wave of the pandemic has already hit our European export markets, compelling some of them to re-impose lockdowns. That could hit our already stagnant export earnings, diluting the beneficial effects of a lax monetary policy.

One can easily add the prevailing high level of political uncertainty as another big downside risk to growth prospects. Political uncertainty is also fuelling inflationary expectations and that, combined with real inflationary pressures, are keeping inflation high.

But the SBP says core inflation in July-August remained in control, perhaps to imply that monetary easing was yielding desired results. The year-on-year increase in overall consumer inflation fell to 8.2pc from 9.3pc in July. Average yearly food inflation in August also declined to 11.3pc in urban areas and to 13.5pc in rural areas from 15.1pc and 17.8pc in July. Even at these levels, food inflation is high enough to push overall consumer inflation in coming months in view of the post-flood supply-side shocks and the continuing locust attack on crops.

The SBP has factored in all this in its 20-21 inflation forecast of 7-9pc. How market supplies are maintained and inflation checked in the near future also depend on how the PTI and our powerful establishment deal with the opposition’s promised street protests to oust the government.

Published in Dawn, The Business and Finance Weekly, September 28th, 2020