Monetary easing amid Covid-19

Updated 18 May 2020

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THE State Bank of Pakistan (SBP) has cut its policy rate once again by a full percentage point to eight per cent. The central bank has reduced the interest rate by 5.25 percentage points since March 17, in four instalments, pulling it down from its peak of 13.25pc.

The obvious purpose is to enable households and businesses to get cheaper finance from banks to survive during the economic disruption caused by Covid-19. How fast banks actually finance day-to-day requirements of households and businesses will be critical in determining whether the central bank has achieved its purpose.

In the first 10 months of this fiscal year, banks’ net fresh lending to the private sector stood at Rs320 billion, down from a little less than Rs588bn a year ago. Data for the full fiscal year showing credit flows to the private sector will tell the real story. How a historic 5.25pc interest rate cut between March 17 and May 15 accelerated credit flows will gradually become evident with the regular updating of private-sector borrowing. So the nation needs to keep a close watch on such borrowing.

An increase in the federal government’s borrowing from banks can be a good thing under current circumstances owing to lower interest rates

The massive rate cut helps the federal government borrow at a cheaper cost from banks through the sale of treasury bills and bonds. Interest rate slashing also aims to help the government make large cash transfers to daily-wagers and bear the cost of refinance offered to banks that make subsidised loans to households and businesses.

The best part of such refinancing to banks relates to the subsidised lending to big companies and small and medium enterprises (SMEs) for keeping their employees on payroll amidst the disruption in economic activities.

So an increase in the federal government’s borrowing from banks owing to lower interest rates can be a good thing under current circumstances. From July 1, 2019 to May 1, net government borrowing from banks totalled Rs1.89 trillion, but part of it (Rs355bn) was used to retire the central bank’s debt.

While announcing its May 15 decision to cut the interest rate, the SBP admitted that easier monetary policy cannot “prevent the near-term fall in economic activity due to lockdowns”. But it can “provide liquidity support to households and businesses to help them through the ensuing temporary phase of economic disruption”.

The fears of an economic recession during the current fiscal year may come true and, in the best-case scenario, the fiscal stimulus plus monetary easing can help the economy grow modestly in the next year. The adviser to the prime minister on finance, Dr Hafeez Shaikh, is hoping for modest 2pc economic growth in the next fiscal.

The SBP claimed in the May 15 monetary policy statement that “the successive policy rate cuts and sizeable cheap loans provided through the SBP’s enhanced refinancing facilities have helped maintain credit flows, bolster the cash flow of borrowers and support asset prices”.

Well, the central bank deserves some accolades for that. But how efficiently credit flows have been “maintained” and cash flow of borrowers “bolstered” and how that have helped in preventing layoffs and operations of small businesses need a deeper discussion. Hopefully, the central bank will take the nation into confidence, at an appropriate time, and divulge key details of the blessings of massive monetary easing.

The SBP should form a high-level committee of bankers and business leaders to address the issues that hamper accelerated credit flows

To make sure that the real purpose of massive and emergency monetary easing — at the cost of millions of depositors’ money — is being met, the SBP will do well if it forms a high-level committee of bankers and business leaders for addressing the issues that hamper accelerated credit flows. The committee can also be tasked with monitoring regularly the quality of service and outreach of online banking that the central bank is trying to promote during lockdowns.

The latest interest rate cut is in response to the central bank’s projection that inflation in the next fiscal year could remain 7-9pc after closing the current fiscal year at the lower end of the “previously announced ranges of 11-12pc”.

For quite some time, the SBP has become visibly forward-looking in its interest rate setting. When it was defending a very high 13.25pc policy rate amidst noisy demands from businesses and sober arguments of independent economists, it was looking at possible inflationary build-ups and not just the inflation number at hand. Now, besides bowing to the national need “to provide liquidity to households and businesses,” the central bank has again based its interest rate easing to future inflationary movements.

But this time the monetary policy statement contains a much-needed warning on a two-sided risk to the inflation outlook: “Inflation could fall further than expected if economic activity fails to pick up as expected next fiscal year. On the other hand, there are some upside risks from potential food-price shocks associated with adverse agricultural conditions.”

With large-scale manufacturing showing a steep decline of 23pc year-on-year in March and with the fate of small industries still hanging in the balance owing to the repeated closure of businesses after the violation of SOPs, agriculture requires greater attention. Agriculture offers hope for lessening the severity of a possible recession during this fiscal year and an economic recovery next year.

But the federal government is still busy finalising the implementation details of the Rs50bn agricultural stimulus package announced earlier and approved by the Economic Coordination Committee on May 13. Agriculturists point out that even the issue of lowering agricultural credit interest rate from 18.4pc to 10pc has not been addressed.

Meanwhile, the Pakistan Kissan Rabita Committee has rejected the package and called it “too meagre” while demanding a 10-fold increase, according to a Dawn report. Other farmers’ associations had expressed disappointment over the size of the package when it was announced in April.

Published in Dawn, The Business and Finance Weekly, May 18th , 2020