THE State Bank has raised its policy rate by 150bps to 13.75pc, hoping that its latest monetary-tightening action will help moderate demand, improve inflation expectations and contain risks to external stability. The success of the latest decision, however, hinges largely on the government’s willingness to clean up the fiscal mess created by its predecessor and exacerbated by the incumbent’s decision paralysis on the question of reversal of huge price discounts on transport fuel and electricity bills. The SBP also expects the government to slash non-interest expenditure led by higher subsidies, grants and provincial development spending, as well as revive normal petroleum levy and GST on fuel next year to achieve fiscal consolidation. This should alleviate pressure on inflation, market rates and the external account. That the bank also ditched its ‘forward guidance’ on interest rates in view of the current uncertainty shows it is now willing to hike the rates in case the government doesn’t put its fiscal house in order. Even though the SBP had boosted the rate by 250bps last month, this step failed to curb inflation or to stabilise the external sector due to lax fiscal policies and continuing energy subsidies.

Besides raising the policy rate, the bank has increased the rates for concessionary working capital for exporters and on loans for purchasing machinery to 7pc and 7.5pc to lessen distortions. In future, these rates will be automatically adjusted in line with the policy rate. The warning that the bank will take action against commercial banks charging excessive premium over and above the policy rate on sovereign debt must help rid the government of their leverage over it. The rise in rates, along with the expected fiscal consolidation — including the reversal of energy subsidies — is projected to increase inflation, which has already touched a two-year high of 13.4pc, and slow down growth to 3.5-4.5pc in the next financial year from the 5.9pc estimated for the current fiscal. Nonetheless, deteriorating external stability that has stoked inflation and led to pressure on foreign exchange reserves and the rupee has left the country with no choice but to swallow the bitter pill. These actions are crucial to meeting IMF conditions for the revival of its funding programme, which will pave the way for additional dollar flows from other multilateral and bilateral lenders. It is time the coalition government took its cue from the bank, cast away its decision paralysis and acted to stabilise the economy.

Published in Dawn, May 24th, 2022