MPS - another U-turn?

The monetary policy is due tomorrow. It is hard to predict what route the committee takes, seeing the decision making pattern in past few policy notes. It is difficult to comprehend what school of thought is the MPC pursuing. A general perception is that decisions are based on economic and political sentiments at that time, and not on fundamental long term economic thinking.

In the last policy minutes, there were 2 members for 200 bps increase, while seven voted for 150 bps hike. “Member voting to increase the policy rate by 200 bps were of the view that future inflationary trends need to be contained today, amid a depreciating PKR. They were also of the view that a greater increase in the policy rate will lower the need for large rate increases subsequently”, reasoned MPC.

Reading from the communication, there is a fair chance of a further rate hike. However, based on last PIB auction where the government fetched Rs50 billion, where it could have gone for Rs200 billion, implies the government (read SBP) is thinking that rates have peaked. Confusion. In Nov18, sentiments were low. The headlines were failed foreign trips, no money coming, IMF uncertainty, and general criticism on PTI’s economic team. Apparently, the news flow back then influenced monetary policy committee and is reflecting in the minutes. This did not happen for the first time - between Nov17 and Mar18, the MPC committee communications had shifted 180 degrees in terms of making assessment of the economy.

Now in Jan19, sentiments are improved and analysts are praising Imran’s foreign policy - money from UAE and KSA is here, China is expected to support and the relations between Pakistan and USA are on the mend. The FTA 2.0 with China negotiations are at advanced stage, US senator is talking about increasing economic cooperation with Pakistan which may bode well for ongoing negotiation with the IMF. The government is about to launch Pakistan first ever Diaspora bond, and the business community is happy with recently announced economic reform package by Asad.

If recent history is any guide, the monetary policy communication is about to take another “U-turn” and the risks to macroeconomic stability might be much less now than those perceived by MPC in Nov18. The buzz is that there is going to be no change in the policy on Thursday and with inflationary pressures subsiding in the fourth quarter of 2019, interest rates might start coming down by Nov19.

That is the story based on reading from the communication in past eighteen months. The SBP and MPC should rather focus more on macroeconomic models and start thinking in medium to long term and should shift from reactionary policy making to proactive approach.

There is no rationale for having 400-450 bps real interest rates - the aggregate demand is already curbed with GDP growth forecast for FY19 being revised down to 3-4 percent. The external funding gap is largely met and the CAD deficit is likely to be trimmed soon. The transmission of 400 bps increase in policy rate from Jul-Nov18 will take its time to impact the macroeconomic stability.

Any further rate hike could be counterproductive as its marginal impact on consumer and private demand is diminishing but its adverse affect on domestic debt servicing is much more. Some may argue that keeping real interest rates in positive territory is good for bridging investment savings gaps - it’s a naive argument as on average 1.5 percent of GDP is dis-saving of government in past five years - higher the fiscal deficit, lower is the government saving - higher the interest rates, higher the fiscal deficit. Some argue that inflation is understated. That is incorrect. If anything, Pakistan’s CPI might actually be overstated in the past year or so. Some may argue that currency depreciation will have its impact on inflation like 2008. But unlike 2008, the food prices in Pakistan are already higher than international prices.

The bottom line is that whatever lens the SBP uses, there is no rationale for rate hike. Let’s see what the MPC outgoing members have in mind to salvage their position.