THE State Bank’s decision to hike its key policy rate by 100 basis points to a 24-year high of 16pc, after maintaining the status quo in its last two monetary policy committee meetings in August and October, is a step in the right direction, even if intended to appease the IMF.
Indeed, the bank has taken the market by surprise; few expected it to boost the borrowing cost, especially with Ishaq Dar, a proponent of low interest rates and a stronger home currency, heading the finance ministry.
This shows that both the ministry and central bank must be coming to heel after the IMF twice cancelled the discussion over its ninth programme performance review, delaying the disbursement of its next loan tranche of over $1bn because of Pakistan’s reluctance to implement the reforms agreed on.
A statement after the MPC meeting on Friday said the decision was aimed at ensuring that elevated inflation doesn’t become entrenched. The rate increase was also required in view of continued slippages on the fiscal side, particularly after the floods that are said to have caused damage and losses to the tune of $30bn.
Even though the SBP governor hinted at halting the rate hike, the revised inflation forecast of 21pc-23pc for the present fiscal, because of stronger-than-anticipated inflationary pressures, shows the bank is still behind the curve.
Faced with an unprecedented external crisis over diminishing foreign exchange reserves and drying dollar inflows, as well as a weakening fiscal position, the government has failed to contain inflation and domestic demand, in spite of severely restricting imports. The rupee has weakened, the narrowing of the current account notwithstanding.
Negative interest rates are a major reason for soaring prices and a weakening rupee; according to the MPC, global and domestic supply shocks, which are raising costs amid the economic slowdown, are spilling over into broader prices and wages, driving cost-push inflation. The hike in borrowing costs should not only target inflation, currently led by negative real interest rates, but also send a strong signal to the government to change its reckless fiscal course and control its spending.
However, monetary tightening alone cannot contain inflation that has devastated millions of households over the last few years. The fiscal authorities must play their part — as the SBP has stressed in its monetary policy statement — by “maintaining fiscal discipline … to complement monetary tightening, which would together help prevent an entrenchment of inflation and lower external vulnerabilities”.
The question is: if the finance ministry will respond to the bank’s counsel. With crucial foreign inflows drying up in the wake of IMF review delays, chances are the bank’s move will ward off further deterioration in the balance-of-payments position. If fiscal slippages continue, the SBP would be well advised to hike the rates more aggressively to ensure the ministry falls in line. There’s no other option left now.
Published in Dawn, November 27th, 2022