Policy rate hike-weak rupee can be 'deadly' combination

Five global central banks, including State Bank of Pakistan, will be making policy announcements this week. The other four are Bank of Japan (BoJ), Bank of England (BoE), Federal Reserve (FED) and Swiss National Bank (SNB).

Decisions on interest rates will surely have a profound impact on the financial market, especially in the current condition when inflation is creeping up like a monster due to ample supply of emergency stimulus provided to fight against the pandemic. Russia, Brazil, Turkey, Czech Republic and Mexico have already hiked their rates earlier. South Korea was the first developed economy to do so in August this year while others are mulling withdrawing their stimulus support.

However, two major global central banks, BoJ and European Central Bank (ECB), have made their intentions very clear; they have already announced that inflation is transitory due to Covid-19 factor.

This week, it is expected that the other four central banks (CBs) too are also likely to adopt a cautious stance and may wait and watch, as the threat of stretching and spreading of delta variants probability has sharply increased.

But FED's action will be keenly watched as it may not hike interest rates in September; it is the size of FED tapering that would matter and give a hint at future interest rate direction. Delay in its quantitative easing tapering will put the Doves on the back foot, which could possibly hold up US interest rate hike until 2023, unless inflation goes out of control. In other words, it's the tapering and its size that will provide the clue.

Pakistan Monetary Policy announcement

It will be too early for SBP to turn hawkish; it should still wait until 1st quarter of 2022, as the next 6-months are very crucial for Pakistan's economy. SBP's message through its last policy announcement has been clear about maintaining an accommodative stance. More importantly, SBP's new Forward Guidance Monetary Tool is very clear about providing future direction and therefore we haven't yet come close to hiking the policy rate.

How is it possible that SBP will make a preemptive hike when inflation is within its targeted range? It is a fact that despite pressures caused by higher global commodity prices, CPI inflation has been fairly tame so far.

Any premature tightening will threaten recovery. Though economy is showing growth in some areas, pressure on the balance of payments position is mounting despite extraordinary support from remittances and the much-needed stimulus acquired from donors. Job conditions are not keeping pace with the population growth.

Under the current situation it is expected of the SBP that through its forward guidance it would first convey a message and then will make a shift towards a neutral stance before making any move. The banking system is already clogged and is struggling, which is why SBP is forced to expand its sterilisation action (usage of its monetary tools) to manage its cash flows by successfully using several heads (domestic/external entries) - tools that were also used by previous governments in the past. Unlike the past, however, we are now on the FATF Grey List. No doubt, SBP is using its monetary tools efficiently, but at current pace it may have reached the high point.

Adding to the problem is the spillover factor caused by unrest and unsettled conditions in Afghanistan. It is important to note that the hike in prices of commodities globally has nothing to do with our domestic demand. Food inflation is because of weakness/flaws, which are caused by policy failure. A relatively complacent approach to the agriculture sector is purely an administrative issue. Wheat can be harvested twice a year and sugar 2 times in 18-20 months period. Rice which is planted in May-June is harvested between October and December. Our policymakers will have to realise that real growth is sluggish and the economy still demands an expansionary policy. Therefore, any policy rate hike in presence of a weak rupee can become the cause of destabilization. Our fragile economy demands further soft funding with more space for recovery.

(The writer is former Country Treasurer of Chase Manhattan Bank)

He tweets @asadcmka

Copyright Business Recorder, 2021