Optimism of MPS

The Monetary Policy Statement (MPS) released by the SBP is refreshingly optimistic. The policy rate has been maintained at 7 percent with the assurance that the stance of monetary policy will remain unchanged in the near term.

The SBP says that ‘the domestic recovery has gained traction’. Consequently, the expectation now is that the GDP growth rate in 2020-21 may even exceed 2 percent. The primary evidence for this is the acceleration in the growth rate of the large-scale manufacturing sector to 7.4 percent in the first five months, buoyancy in cement sales and petroleum products and recovery in automobile sales.

However, there is no mention of the catastrophic drop in the cotton output. Arrivals have plummeted by as much as 34 percent up to January 2021. This alone could reduce the growth rate of the major crop sector by 6 percent and impact negatively on the GDP by 0.5 percent. Further, the downstream implications on the output of textile sector will be significant.

The growth rate of the large-scale manufacturing sector is artificially high because of the depressed level of output in the corresponding period of 2019-20. With respect to 2018-19 the increase is only 2 percent. Further, the growth is not yet broad-based. It is concentrated in a few industries like cement, cigarettes, fertilizer and pharmaceuticals. Output continues to decline or show low growth in industries like petroleum refining, cotton yarn and cloth, steel products, vegetable ghee, beverages, consumer durables, etc.

Turning to the demand side of the economy, private investment has yet to show recovery. Import of machinery has shown little growth up to December 2020. Development spending releases are down by over 17 percent in real terms as of the last week of January 21 as compared to the level in the corresponding period of 2019-20. More substantively, real household consumption expenditure is likely to show limited growth because of the prevailing high levels of unemployment and poverty.

The SBP is also optimistic that the rate of inflation will remain unchanged in the range of 7 to 9 percent during the remainder of 2020-21. Any blip due to higher utility tariffs is apparently going to be transient in nature. The claim is also made that prices of wheat, pulses and rice have declined.

There is a risk, however, that the rate of inflation could approach double-digit in coming months due primarily to cost-push factors. First, we may have seen only the first round of increases in utility tariffs. The fuel adjustment charge could also be higher because of the increase in the import price of RLNG. Second, oil price has risen sharply to above $55 per barrel. This has been reflected only partially up to December 20 in import price of crude and petroleum products. Unless the Government decides to take a big cut in the petroleum levy, the domestic prices of HSD oil and motor spirit will rise significantly and exert upward pressure on the price level via higher transport costs.

Third, as the world economy recovers, there will be a tendency for commodity and other product prices to rise globally. This could mean higher prices of palm oil, iron and steel and fertilizer, etc. Overall, stronger measures will be required to keep the inflation rate in the range of 7 to 9 percent.

The MPS has also highlighted the fact that the budgetary position is under control, as measured by the increase in the size of the primary surplus, in the first five months of 2020-21. Apparently, there has been ‘healthy’ growth in revenues. But is a 6 percent growth in FBR revenues commendable when the two tax bases of large-scale manufacturing and imports have increased more by 13 percent and 10 percent respectively? The growth rate will jump up substantially given the lower base of revenues in 2019-20 after the COVID-19 attack. But even with this jump there is likely to be a short fall in FBR revenues of over 400 billion rupees in 2020-21.

The budgetary position also changes somewhat when the focus shifts to the broader measure of the deficit. According to the recent monthly review by the Ministry of Finance the budget deficit has increased in the first five months by 22 percent in relation to last year’s level. Achievement of the target of restricting the budget deficit to 7.1 percent of the GDP in 2020-21 will require that in absolute terms the size of the deficit remains largely unchanged. Clearly, the remaining months of the on-going financial year will require stronger budgetary control.

Perhaps the most worrying development is that of the transformation of a current account surplus into a deficit of sizeable magnitude in December. Imports during the month showed a big jump of 32 percent due, first, to higher imports of agricultural items. Second, imports of automobiles have virtually trebled. Third, there are visible increases also in imports of various raw materials and intermediate goods.

There is also the beginning of a slowdown in the growth rate of remittances. It was 27 percent in the first five months and has declined to 16 percent in December. The remittances from the Middle East constitute 58 percent of the total inflow. Here the drop is greater, with growth rate at only 4 percent in December. In fact, remittances from other GCC countries have fallen. Are we seeing the dire predictions on the global fall in remittances of the World Bank beginning to be realized?

However, the SBP remains confident that the current account deficit will be restricted to 1 percent of the GDP in 2020-21. Further, there is no mention of the substantial deterioration of the surplus in the financial account by over $5.5 billion and the reduction in the overall balance of payments surplus by almost 70 percent in the first six months of 2020-21. Instead, comfort is demonstrated in the highest level of reserves at $13 billion since December 17. How much of this is due to the increase in borrowing and placement of swap funds with the SBP?

Overall, the apparent optimism of the SBP on growth, inflation and the two deficits may be interpreted as a way of preserving business confidence at this time of political stress in the system. It is important that the Central Bank of the country always maintains an autonomous perspective on the economy.

(The writer is Professor Emeritus at BNU and former Federal Minister)

Copyright Business Recorder, 2021