The monetary policy is due today. Solely looking at inflation, the decision could be in favour of status quo. Few members of the committee might vote for a rate cut. That was mainly the summary of last monetary policy released in July; where eight out of nine members voted for status quo while one voted for 25 bps cut.
Current account deficit for FY17 was already released by that time; but highest deficit (4% of GDP) since FY08 was not enough for policymakers to even think of monetary tightening. By that time, fiscal deficit was provisionally revised to 4.2 percent of GDP; but no sane analyst or economist expected the deficit to stand at that level. However, the SBP took it at face value, and now the actual numbers at 5.8 percent of GDP, shouts for tight fiscal policy.
The twin deficit problem could not be more explicit now; the question is that whether the MPC would take it seriously. The balance of payment concerns should not be ignored in terms of making policy. The question is how could monetary policy tightening help in slashing current account deficit?
For this, the need is to understand the causes of higher CAD at the first place. Yes, low commodity prices have their fair share in exports decline; but this should have even depressed imports more. But that is not the case - exports are struggling to grow while imports are leaping forward.
There are two reasons of higher imports -a) the demand pull factor - the monetary easing has triggered demand which has its fair share of imports. b) Economy in an expansionary cycle - machinery imports are high which would result in higher future other imports.
The demand part is partially attributed to monetary easing cycle started in Nov14. Many domestic industries have protection from imports, while there are not many incentives for exports. The returns in domestic market productions are much higher than that for exporting products. With so many gaps in filling domestic demand, no exporting business is as such expanding.
Thus, to curb trade deficit, the monetary policy has to be innovative with more independence of the SBP in disbursing incentives handouts/tax refunds. But the gap of imports and exports has widened enough which makes the case of curtailing import demand more compelling.
The monetary easing has its magic on private credit. With fiscal deficit expanding, the government is coming back to commercial banks. This would have some crowding out and may slow down the growth momentum. But to ensure the slowdown, a hike in interest rates is not a bad idea. But that might not happen tomorrow, seeing low inflation. But why inflation is keeping too low when economy is expanding and demand driven consumer growth is booming?
Apart from low commodity prices, artificially low imported inflation has its role to play. The REER has appreciated by 20 percent since 2004; this is implying that we are not factoring in the impact of trading partners’ relative inflation in our economy. The second factor is that petroleum prices have been kept too low in Pakistan relative to similar oil importing economies.
If exchange rate adjustment has adverse consequences on debt servicing, increasing petroleum prices can generate higher fiscal revenues to lower deficit driven debt. Yes, it’s not in the domain of MPC, but the MPS can recommend government to do so. It used to advise on fiscal matters a few years back but now the SBP seems to be a subservient of ministry of finance.
Let’s see what life the new PM would bring to SBP. There is not much hope pinned on today’s statement. Since, current account was a bit low in August and inflation under 4 percent, the verdict is likely to be of no change.
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