Monetary policy in tricky times

Published November 22, 2021
In less than five months of this fiscal year, the rupee has lost 11pc of its value falling to 175.23 to the US dollar on Nov 19 from 157.76 on June 30. — AFP/File
In less than five months of this fiscal year, the rupee has lost 11pc of its value falling to 175.23 to the US dollar on Nov 19 from 157.76 on June 30. — AFP/File

The first step was apparently not “measured”. A mere 25 basis points increase in the policy rate announced on September 20 was not enough to contain growing inflation. Raging winds of inflation ignored it and intensified “inflationary noise” and “inflation expectations.”

(National average year-on-year consumer inflation rose 9.2 per cent in October from 9pc in September).

On November 19, the State Bank of Pakistan (SBP) had no other option but to use the full might of monetary tightening to calm the vortex of inflationary pressures. It raised the policy rate by 150bps to 8.75pc — much to the chagrin of the government for which the cost of commercial bank borrowing has now become prohibitive. The doors of borrowing from the central bank are already closed on the government which means it will have to make further cuts in its development budgets. Governments in Pakistan seldom bother to reduce administrative expenses. We all know that.

The big rate rise will also dampen the demand for bank credit of the private sector thereby moderating the current growth momentum. And, the private sector’s fresh borrowing from banks would also become too expensive thus forcing them to compromise on their business expansion plans, reduce output and even lay off workers where necessary. Sadly then, the recent monetary tightening is also not “measured” — or so it seems. And, common sense dictates that a 150bps rate rise after a 25bps increase should not be termed as “gradual” either.

A full dose of monetary tightening of 150bps is expected to contain inflationary pressures by suppressing demand which would ultimately depress growth momentum and may even affect job creation

After preparing the ground for “inflation targeting” back in March this year, the central bank had promised that monetary tightening — as and when it becomes necessary — would be “gradual” and “measured”.

The purpose was to lend the government and the private sector the confidence they needed to design and implement medium-term economic and business growth policies.

The March 2021 monetary policy statement of the SBP was significant in that it had projected a numerical value for the “medium-term” inflation outlook — 7-9pc — in a clear sign of initiating inflation targeting at an appropriate time. Inflation targeting makes it possible for a central bank to focus on managing inflation without bothering about the economic growth rate. Pakistan’s central bank is required under the Constitution to take care of both inflation and economic growth. It, therefore, cannot start inflation targeting unless a constitutional amendment clears the way for it.

It is not clear yet whether the recent amendment to the laws that govern the central bank (introduced through the SBP Banking Services Corporation (Amendment) Bill 2021 has accorded the central bank the “autonomy” it required for inflation targeting. (This bill, was among the 33 bills bulldozed through a joint session of the Parliament just two days before the announcement of the latest monetary policy — a week ahead of the schedule).

While announcing the policy rate hike on November 19, the SBP informed the nation that from now onwards it would review its monetary policy eight times a year instead of six times a year. And, it also shared the schedule of the next five meetings of its monetary policy committee to be held before the close of the current fiscal year in June.

This is also a clear indication that the SBP intends to move towards ‘inflation targets’ though it is yet to make a formal announcement in this regard. Central banks that practice inflation targeting review their monetary policies more frequently than others.

Back in September when the SBP had raised the policy rate by just 25bps inflation, Consumer Price Index inflation was 9pc — the threshold where it starts hurting economic growth in the country, according to the central bank’s own finding. But the reason why the SBP had avoided a higher policy rate hike at that time was that it rather wanted to keep the monetary policy “appropriately supportive of growth”.

Withdrawal of energy subsidies and increase in domestic oil prices continue to fuel inflation at the moment. The International Monetary Fund (IMF) is not willing to allow the continuation of subsidies and it also wants the government to further raise tax revenue which means petroleum development surcharge cannot be cut to moderate domestic fuel oil price hikes.

The ongoing rupee depreciation, meanwhile, also keeps fueling inflation. In less than five months of this fiscal year, the rupee lost 11pc of its value falling to 175.23 to the US dollar on Nov 19 from 157.76 on June 30, as imports continued growing too fast expanding the current account deficit in the process. In four months of the fiscal year, the C/A deficit surged to $5.084 billion from $1.313bn in the same period of the last year, according to the latest balance of payments report.

A full dose of monetary tightening of 150bps is expected to contain inflationary pressures by suppressing demand which would ultimately depress growth momentum and may even affect job creation. But then, the economic stabilisation that the central bank wants to achieve through monetary tightening — on the insistence of the IMF — had become necessary to contain the overheating economy. Why does Pakistan economy overheat so soon? In the present case, it is in the second year of strong recovery but in most cases, it is in less than five years and is a point to ponder.

Unless structural flaws of the economy are addressed adequately (which requires not only economic wisdom but also a strong political will and a governance structure free from the frequent intervention of non-democratic forces), sustainable economic growth would remain elusive.

Published in Dawn, The Business and Finance Weekly, November 22nd, 2021

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