HAVING halted monetary tightening after cumulatively raising the borrowing cost by 800bps to 15pc since last September, the State Bank seems to think that interest rates have peaked — at least for now.

The decision is in line with both domestic market expectations and current trends in emerging world markets where central banks are keeping policy rates unchanged to avert a recession. Yet the State Bank has rightly avoided linking its current action to future policy direction in order to not raise public expectations of early monetary easing; it is the data on inflation, fiscal and external account developments and commodity prices that will continue to dictate future monetary policy decisions.

The policy rate will likely remain at its present level for several months, even if the bank sees reason to ease it. The State Bank has valid reason for applying such caution.

The downside risks to inflation and the external account remain. For example, it is still not clear how much damage the floods have caused to agricultural output. The destruction of food crops would have worsened the existing supply chain disruptions, pushing headline and food inflation further up. Besides, it remains unclear if international commodity prices will continue to taper off in the medium to long term. If the trend does not hold for a longer period, it will put new pressure on the nation’s current account and foreign exchange reserves.

For now, the monetary policy decision is informed primarily by the moderation of domestic demand as reflected in the drop in sales of cars, cement etc, due to higher interest rates and administrative steps to discourage unnecessary imports, easing pressure on foreign currency reserves, fiscal consolidation, and the likely disbursement of stuck-up IMF funds towards the end of August.

Read: Stability with growth

Although the State Bank is hopeful of doubling its reserves to $16bn by the end of this fiscal, as it already has secured bilateral and multilateral commitments of $37bn against its financing needs of $30bn, there is no room for the fiscal and monetary authorities to drop their guard.

The monetary policy statement projects the economy to grow in the range of 3pc to 4pc this year. This is the growth level the economy can support without facing another balance-of-payments crisis. If the economy is to grow faster, we will have to pursue policies to attract FDI, boost domestic agricultural and industrial productivity to produce export surplus, and incentivise remittances from overseas Pakistanis.

As ‘economic stability’ returns, both the government and State Bank will find themselves under enormous pressure from different lobbies to shift gear and adopt pro-cyclical policies for higher growth. It will be tempting for the ruling coalition to yield, given that the next elections are barely a year away. But if they do, it will be disastrous for the economy and may delay recovery for a much longer time.

Published in Dawn, August 24th, 2022