OPINION: Stability with growth

Published November 23, 2021
A photo of State Bank of Pakistan Governor Dr Reza Baqir. — Photo courtesy State Bank of Pakistan
A photo of State Bank of Pakistan Governor Dr Reza Baqir. — Photo courtesy State Bank of Pakistan

PAKISTAN’S economic growth history is striking for its lack of stability. Repeated boom-bust cycles — rapid economic growth followed by a crash — cause uncertainty in livelihoods of our citizens and undermine the ability of our businesses to plan for the longer term. One key cause of these repeated boom-bust cycles is delayed policy action to prevent overheating.

Friday’s decision of the State Bank’s Monetary Policy Committee (MPC) to raise the policy rate by 150 basis points, and moderate the pace of growth, is a step towards the goal of maintaining stability with growth. In this context, it is important to understand why the SBP moved the MPC a week earlier, the considerations behind an increase of 150 basis points, and how the central bank sees monetary policy evolving in the near term to preserve stability with growth. Before addressing these three key questions, it is important to note that with Friday’s action on the policy rate, monetary policy continues to remain supportive of growth as indicated by continued negative real interest rates. SBP expects growth of around 5 per cent for this fiscal year, a four-year high.

In the September Monetary Policy Statement, the MPC had already indicated that the highly accommodative monetary policy settings that had been maintained since the onset of Covid in March 2020 were no longer needed. This policy response helped Pakistan emerge from the Covid shock earlier and with much less economic damage than almost any country in the world. However, with growth improving continuously since last summer and fears surrounding the Delta variant receding, the MPC noted that it was appropriate to begin tapering the monetary stimulus to prevent overheating. Accordingly, the policy rate was raised in September and future moves were expected to be gradual in the absence of unforeseen circumstances.

Since then, however, things did not turn out fully the way the MPC had anticipated. In particular, inflation and the current account deficit have risen somewhat faster than expected because of both domestic and global factors. At the same time, prospects for economic growth have also strengthened further. Such variances between projections and outcomes have become more pronounced in the face of uncertainties related to an unprecedented shock like Covid. For instance, developments in international commodity prices and global inflation over the last few months have challenged central banks around the world.

When outcomes are different from projections, it is important to be forward-looking and recalibrate the best course of action given the updated information. It was in this context that the date of the MPC meeting was brought forward. In addition, learning from this experience and international best practice, the frequency of MPC meetings was also increased from six to eight times a year, enabling faster course correction in the event of any future material deviation of outcomes from forecasts.

In deciding how much to raise the policy rate, the MPC weighed several factors. Since the extent of inflation and current account developments had been moderately more than that anticipated at the time of the September MPC meeting, the pace of tapering monetary stimulus needed to be somewhat more than the gradual pace anticipated at that time. Even before the announcement that the MPC meeting was being brought forward, analysts had already priced in a hike of at least 100 basis points in the policy rate in the November meeting. After careful deliberation, the MPC came to the view that raising the policy rate by 150 basis points would strike an appropriate balance between protecting the outlook for inflation and the current account deficit while also supporting stable growth.

So where does Friday’s move leave us in terms of the future path of monetary policy? Since the MPC began providing forward guidance in January, it has been centred on two major components: (a) the end goal of mildly positive real interest rates and (b) the pace at which this goal would be achieved. The end goal remains the same. However, given the more than expected rise in inflation and current account deficits in recent months, it is appropriate that the pace of achieving it be somewhat accelerated. Friday’s rate action was a significant move in this direction. As a result, and given the currently available information, the MPC expects future moves to be smaller in magnitude, such that the path to mildly positive real interest rates is likely to be less steep from here.

When growth is strong, the path of least resistance may be to not take any action that may appear to undermine growth. After all, why not go along with the trend and avoid any action to risk unpopularity. If a bust ensues, blame can always be apportioned to external factors beyond the control of policymakers. Such a course, however, has to be avoided as it would perpetuate repeated boom-bust cycles as in our past. In this light, it is imperative to make a break from the past and gear policy to give equal weight to stability and growth; we cannot afford to let our history rob us of our future.

The writer is Governor, State Bank of Pakistan

Published in Dawn, November 23rd, 2021

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