THE State Bank has done it again. For the third time, it has held an unscheduled meeting of the Monetary Policy Committee and decided to slash the key policy rate by 100 basis points. With the move the total interest rate reduction since mid-March, when the lockdowns and disruptive impact of the Covid-19 pandemic hit Pakistan, comes to 625bps. This is, quite possibly, the sharpest monetary easing in the country’s history, since it represents a near halving of the policy rate in a matter of three months. And this may not be the end of the cycle either as further rate cuts in the months ahead remain a distinct possibility.

There is little doubt that the situation facing the country calls for extraordinary measures. The rate cuts have been well received by the business community and have had a significant impact in terms of easing debt-service expenditures of the government, though specifically quantifying the impact is difficult. The economy is now in the midst of a slowdown the likes of which we have never seen before, with the growth rate plummeting to negative territory, and the clouds of uncertainty that have produced this plunge far from lifting. At the same time, the global economy is also undergoing a sharp deceleration, with ominous implications for the sources of Pakistan’s external earnings: remittances and exports. The optimistic take on elevated foreign investment in FY2020 owes itself almost entirely to the renewal of telecom licences earlier in the fiscal year, so this data is hardly likely to persist much into the future, or serve as a driver of future growth.

The times call for using all available levers to help the economy, but that doesn’t mean that the dangers associated with these moves have receded. Lax monetary policy risks creating asset bubbles, and coupled with the tax incentives given to the property sector, the benefits could easily prove elusive for the real economy as money flees for speculative returns on offer in property and stock markets instead. It can also adversely impact the exchange rate, which is already under pressure. The State Bank says that with reserves finding strength in the past week through $1.5bn worth of (debt-creating) inflows, coupled with a stable current account and external financing requirements met comfortably, this danger is manageable. We can only hope it is right. It would be wrong to fault the decision to slash rates so steeply, but it is equally important to emphasise that the State Bank must remain mindful of the dangers associated with such moves. Pakistan has to now undertake another round of steep macroeconomic adjustment of the sort that was just being completed when the pandemic hit, and coupling this with the imperative to shore up a flagging economy will prove to be a tough high-wire act.

Published in Dawn, June 27th, 2020