THE State Bank of Pakistan (SBP) has raised its key policy rate by 50 basis points to a three-year high of 6.5 per cent effective May 28 for the next two months.

Financial markets were well expecting this move due to rising international oil prices and unabated deterioration in the external account.

These factors do not augur well for the sustenance of the current high growth- low inflation trajectory. The average headline Consumer Price Index (CPI) in ten months of this fiscal year remained moderate at 3.7pc against the full year target of 6pc chiefly due to low food inflation.

But as global oil prices have already crossed $80 per barrel mark and are seen heading northwards, Pakistan fears a pick up not only in imported inflation but also in domestic cost-push inflation.

With the current government leaving, can the external sector problems be addressed through occasional shots in the arm effectively enough to sustain a high economic growth?

Can a higher policy rate contain inflationary pressure effectively without a matching fiscal response from the government?

The government ought to ensure: a stricter handling of the fiscal deficit, curbs on financial leakages, corruption and reckless spending, productive efforts to document the economy, checks on cartelisation and monopolies, and removal of bottlenecks in the supply of goods and services.

About a week before monetary tightening, the central bank got stricter with forex companies to ensure some stability in the open currency market. In the interbank market it has already been managing post-depreciation rupee-dollar parity.

However, unless there is an inflow of a few billion dollars in the national exchequer, as government officials are expecting before the close of June, the dwindling SBP forex reserves are barely enough to cover even two and a half months of imports.

In order to cushion against that, tightening the interest rates makes all the sense. But is it realistic to expect the kind of fiscal response in an election year that is as required in fighting inflation as is a tighter monetary policy?

Secondly, can the external side problems be addressed through occasional shots in the arm effectively enough to sustain a high economic growth? Since the current political government is about to exit shortly, they may or may not be able to do much on fiscal management.

It depends on a variety of factors, including the highly dreaded scenario of delaying the elections by a few months.

For the massive $14bn current account deficit in ten months of this fiscal year against total SBP reserves of $10.32bn (as of May 18), additional borrowing from multilateral lending agencies, coupled with doubling of efforts to boost exports and remittances, can help substantially.

Fiscal and monetary policymakers claim these issues are at the back of their minds but they tend to express them in public using more guarded words and phrases.

The growth of private-sector credit demand is already subdued during this fiscal year compared to the last fiscal, and whether private sector businesses will be able to borrow up to their requirements from banks after the interest rate tightening is yet to be seen.

On the other hand, if private sector borrowing from banks falters then banks would naturally rely more on public sector borrowing. But after the installation of a caretaker government next month that is not a very likely scenario as caretakers traditionally refrain from overspending.

But for the next government, will availability of enough lending room at banks for the public sector would be a good thing? During this fiscal year, up to May 18, the government borrowing from banks totalled Rs862bn, slightly higher than Rs856bn in the same period of the last fiscal year.

Private sector borrowings from banks up to May 18 of this fiscal year were a little less than Rs527bn, a bit higher than Rs504bn in the same period of last year.

Published in Dawn, The Business and Finance Weekly, May 28th, 2018