Markets have grown used to witnessing a discord between monetary and fiscal policies.

To what extent and for how long a stable monetary policy can cover up fiscal indiscipline is a subject worth probing by monetary economists.

Not only did former finance minister Ishaq Dar react sharply to the State Bank of Pakistan’s (SBP) July 5 move of letting the rupee fall by 3.1 per cent in one go, he also reminded the nation of the presence of a fiscal and monetary coordination board that he thought should have been consulted in case the central bank wanted a major exchange rate readjustment.

One expects that the minister would be equally perturbed over fiscal indiscipline which, at times, makes it difficult for monetary policy makers to set policy direction. The SBP, in its latest monetary policy review, has once again kept its key policy rate unchanged at 5.75pc. And it has cited many plausible reasons for the decision.

But let’s take a quick look at some facts.

Fiscal deficit has shot through the target, government borrowing remains excessively high, circular debt of the power sector is being restructured, tax collections are not only short of target but continue to remain at around 50pc of the tax capacity, and development budget disbursements still remain short of the original targets.

“All these things are symptoms of continued fiscal indiscipline,” opines a source close to the monetary policy committee of the SBP. “Whether, and how, a stable monetary policy can be helpful in promoting economic growth amid such fiscal indiscipline must be examined for improving the quality of policy inputs.”

While announcing its monetary policy decision, the central bank gave a crisp account of some current macroeconomic indicators besides detailing its own assumptions.

And as expected, it reminded the nation that “underperformance of both exports and workers’ remittances greatly impinged upon the current account deficit which reached $12.1 billion in FY17 (from just $4.867bn in FY16).”

The SBP also gave a veiled warning that this ultra-high current account deficit “highlights near-term balance of payments challenges.”

“Weaknesses in the export sector could have been plugged had our fiscal managers been more prudent in dishing out an incentive package for certain export industries,” says a former member of the monetary policy committee. “They are there without ensuring whether they are helping exports grow or whether the incentive money could be used better elsewhere for export promotion, such as capacity building and innovation.”

“This is one example of how fiscal imprudence can dilute the benefits of a stable monetary policy (stable interest rates for exporters in this case),” he says.

Similarly, when overdue export rebates keep building up, their effect on export performance is bound to dilute export competitiveness gained in a stable interest-rate regime, business leaders say.

The SBP has left its key policy rate unchanged citing its own projection of a lower than targeted headline inflation rate (4.5 to 5pc against 6pc), adding that this projection is based on “lower than anticipated international oil prices, recent behaviour of CPI [Consumer Price Index] inflation in June 2017, stable administered prices and lower inflationary expectations.”

It also says that headline inflation “is expected to remain lower than the earlier outlook … mainly on the back of favourable supply conditions.”

Whereas growth in large-scale manufacturing (LSM) and higher private sector credit flow in FY17 are two strong indications that supply conditions may remain favourable, the twin developments combined with high growth in imports are sure to keep domestic demand up, creating demand-induced inflation.

So, it is difficult to predict whether inflationary expectations would also remain low, more so if the fiscal belt is not tightened; the possibility of which is remote in a pre-election year.

In the first 11 months of the outgoing fiscal year, LSM grew 5.7pc against just 3.4pc in the year-ago period. And private sector credit distribution reached an all-time high of Rs748bn in FY17 against Rs446bn in FY16.

Part of the credit for these developments goes to a stable monetary policy that kept the cost of formal finance for businesses in check.

“But it’s time to undertake a study on the financing mix of the private sector and what the percentage of its cost of bank borrowing is in relation to the cost of production,” suggests a former deputy governor of the SBP.

“The answer to the second part of the question will help the central bank make more informed decision on policy rate setting.”

In the last fiscal year, the government chose to borrow heavily from the central bank and less from the banking system.

Net government borrowing from the SBP totalled Rs908bn in FY17 against net retirement of Rs487bn in FY16. Its net borrowing from scheduled banks totalled Rs179bn, only a friction of what it had borrowed from them a year earlier — Rs 1.28tr.

Though switching over from central bank borrowing to scheduled bank borrowing in one year, and doing the opposite of it can often make sense, it should not become a trend.

“More prudent fiscal management requires a right balancing between the two sources of funding fiscal deficit. This, too, is a sign of fiscal indiscipline and it has implications for the banking system.”

Published in Dawn, The Business and Finance Weekly, July 31st, 2017