Hoping for the best

Published January 3, 2022

Inflation posed an immediate challenge for Pakistan in 2021. But in 2022 inflationary pressures should ease — thanks to a double dose of monetary tightening administered towards the end of 2021.

However, the government will face some other big challenges like managing its fiscal balance, checking the current account deficit and maintaining economic growth momentum. Even before the 250 basis points interest rate tightening between Nov 22nd and Dec 15th, the shortage of gas and electricity had started taking its toll on the growth of industrial production. (Large-scale manufacturing output growth reading was below 3.6 per cent year-on-year during July-Oct).

2022 promises the unfolding of several exciting developments in inflation management through monetary policy

The current account deficit for July-Nov stands at 5.3pc of GDP and thus, worryingly large. But containment of import growth being obtained through a tight monetary policy should help provide “some” ease to the current account deficit. Economic growth in 2022 is, however, bound to suffer due to compression in demand after monetary tightening and an erratic supply of energy to industries. An early sign of the looming compression in aggregate demand will be seen in the decelerated growth rate of consumer credit (minus mortgage finance —thanks to the government’s ongoing Naya Pakistan Housing Scheme).

Inflation, however, may not be as big a challenge in 2022 as in 2021. International fuel oil prices have already started easing. And, the global economy is growing slower than initially expected raising minimal chances for oil prices to shoot up.

This, combined with an expected improvement in the current account deficit should put lesser pressure on foreign exchange rates in 2022 than in 2021.

That means lower imported inflation. With lower imported inflation and slower growth in aggregate demand due to monetary tightening, overall inflation can be expected to start declining from the second quarter of 2022 — if not from Jan-March. (In November 2021, year-on-year consumer inflation soared to 11.5pc). But, if the current energy crisis persists, energy products are made costlier more frequently, domestic and international food prices rebound and prices of essential items are not administered effectively then inflation may become stubborn. In that case, the SBP should opt for further monetary tightening — and, some inflation easing should start from the second half of 2022 (ie the first half of 2022-23).

A very disturbing characteristic of inflation in 2021 was that the poorer section of our population had to brave a higher level of it. Yearly inflation measured by the Sensitive Price Index (which relies on a basket of most essential items of daily use) entered the double-digit zone right from Feb 2021 and never returned to a single digit in the next nine months. It was at its highest — 17.4pc — in November 2021.

Containing prices of some of the 51 most essential items of SPI basket (like wheat flour, rice, milk, sugar, pulses) was possible through strict enforcement of laws governing over-pricing and unfair market prices. But provincial governments failed to do that. The federal government relied on providing relief to consumers under one package after another. Such packages that have become more of a political stunt in Pakistan than anything else, never meet their objectives. The 2021 consumer relief packages were no exception.

One important reason behind higher inflation in 2021 was that the federal government restarted borrowing from the central bank. Latest State Bank of Pakistan (SBP) stats put such borrowing (essentially additional currency printing) at Rs603.7 billion between July 1 and Dec 10, 2021.

In the past two fiscal years, the government had rather retired the central bank’s debt on a net basis — Rs83bn in 2019-20 and about Rs1.038 trillion (repeat trillion) in 2020-21.

The parliament is yet to approve a law, on the International Monetary Fund’s (IMF) insistence, to put a stop to the federal government’s borrowing from the SBP. The imposition of a complete ban on the government to borrow from the central bank of its own country is outrageous. All political quarters and many economists are, therefore, contesting this move in the name of Pakistan’s sovereignty.

The IMF has tied this and some other pre-conditions to the revival of its stalled balance of payments support funding. So, the issue cannot be delayed forever. The two sides may find a more graceful solution to this thorny issue pretty soon. The government’s borrowing from the central bank may not be stopped forever but it could be made limited and linked to the fulfilment of some fiscal disciplinary conditions. This means from 2022 onwards, the SBP will be able to fight inflation through monetary tightening without any fears of the government borrowing from SBP frustrating its moves.

But won’t that make the government all the more dependent on commercial banks? Certainly yes. And banks were dictating treasury bills and bonds rates when the government desperately needs funds and could not resort to central bank borrowing. They did this even before the double dose of monetary tightening was administered.

Realising the potential threat this behaviour of banks can pose to the economy the SBP has started pumping in liquidity through its open market operations not just for a week or two but for two straight months. A sufficiently liquid money market may help the government borrow from banks at rates not artificially raised by “greedy” banks.

This, in turn, would keep in check the cost of the government’s domestic borrowing whose servicing contributes to the expansion of the fiscal deficit. The year 2022 promises the unfolding of several exciting developments in inflation management through monetary policy. Let’s hope for the best!

Published in Dawn, The Business and Finance Weekly, January 3rd, 2022

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