Will Baqir cut rates?

Updated November 18, 2019

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November, the fifth month of our fiscal year, is about to end. But we still don’t know how large-scale manufacturing (LSM) faired in the first quarter i.e. July-September.

Until Nov 14, the Pakistan Bureau of Statistics (PBS) continued to display on its website the July-August LSM performance, showing a year-on-year output fall of 6.04 per cent.

Businessmen continue to lament that industrial production is not picking up and the fall in the consumers’ purchasing power is evident from the declining sales of companies and waning buying euphoria. In all likelihood, the decline in the LSM output continued through the first quarter. With LSM yet to come out of a slump and consumer demand stultified, domestic economic activity is sagging and growth in exports remains nominal.

Total merchandise exports grew to $7.54 billion in July-October from $7.27bn a year ago, showing a volumetric increase of $277 million or $69.25m per month. At this rate of growth, total exports in 2019-20 can remain below $23bn even if we discount the export-damaging effects of business lockdowns, sit-ins and road blockades.

Meanwhile, remittances in July-October slipped to $7.48bn from $7.62bn last year. If this trend persists — and chances are that it can — then total remittances in 2019-20 should, at best, remain intact at the 2018-19 level of $21.84bn.

A gradual easing of monetary policy is essential for reinvigorating economic activities

The merchandise import bill in July-October shrank to $15.32bn from $18.96bn last year. Since the government has started liberalising imports of industrial inputs to take LSM out of slump, one cannot expect any further decline in the current average monthly import bill, which comes to about $3.83bn. This means the total annual import bill should be close to $46bn in 2019-20.

The trend suggests that home remittances will fetch less than $22bn. If we add to it roughly $23bn of export earnings, we get $45bn — $1bn less than our estimated import bill of $46bn. These are just informed estimates. Actual outcomes cannot be poles apart unless the dynamics of external trade and remittances change dramatically.

In the first four and a half months of this fiscal year, Pakistan attracted around $713m net foreign portfolio investment, more in government securities and less in equities. But net inflows of foreign direct investment remain shallow — just $385m in July-September.

Clearly, external-sector fundamentals are still not strong in spite of recent gains in the current account, exchange rates and foreign exchange reserves. They cannot become visibly strong unless overall foreign investment and exports begin to grow much faster and remittances stop shrinking.

Even then, Pakistan will remain dependent on International Monetary Fund (IMF) loans and other sources of foreign funding in the near future owing to the growing requirements of external debt servicing. This means our fiscal account, which recorded a huge deficit of 8.9pc of GDP in 2018-19, will remain under stress for quite some time — more so if political stability and tax revenue targets continue to remain elusive.

So what can be done?

Reinvigorating economic activities and lifting consumer demand can be helpful. To make that happen, a gradual easing of monetary policy is essential.

After losing 31.7pc value against the dollar in 2018-19, the rupee has made a small recovery of 2.9pc in the first four and a half months of this fiscal year. After borrowing Rs3.16 trillion from the central bank in the last fiscal year, the federal government has brought such borrowing down to only Rs122bn so far this year.

The government is currently borrowing heavily from commercial banks and has promised to reduce its borrowings from the State Bank of Pakistan (SBP) — or inflation-fuelling note printing — to zero. Nominal cash printing and some stability in exchange rates have created some room for interest rate easing.

But whether the SBP goes for it now or waits for a further decline in headline inflation of 11pc in October, down from 11.4pc in August, is difficult to predict.

In the first four months of this fiscal year, the private sector has made no fresh borrowing from banks whereas it borrowed Rs223bn a year ago. Elevated bank interest rates are apparently a key factor behind it. The benchmark six-month Karachi inter-bank offered rate (Kibor) that serves as the anchor for most of short-term floating interest rates was at 13.27pc on Nov 13, up from 9.64pc on Nov 13 last year.

Easing interest rates also seems in order because it is not well established whether inflation is still driven by demand, the taming of which requires a tighter monetary policy.

Business leaders and some eminent economists, including Dr Hafiz Pasha, Dr Kaiser Bengali and Dr Ashfaque Hasan Khan, have been arguing for some time that inflation has now become cost-push i.e. a higher cost of production is making goods and services costlier.

The cost of production is increasing owing to costlier finance as well as other factors, including enhanced energy and farm input prices amidst the withdrawal of subsidies.

But there is no denying the fact that throughout 2017-18 and also in the first half of 2018-19, inflation was largely driven by demand requiring the tightening of interest rates. Now perhaps the reverse of it is true, at least in part. Let’s see when the central bank begins interest rate cuts. In September, it left its policy rate unchanged at 13.25pc. Next policy review is due now.

Published in Dawn, The Business and Finance Weekly, November 18th, 2019