The MPC projections

The last meeting of the Monetary Policy Committee (MPC) of the SBP was held on the 14th of December 2021, after the meeting on the 17th of November 2021. Combined, these two meetings have resulted in a rise in the SBP policy rate by 2.75 percentage points.

The surprise is the big change in projections of some of the key macroeconomic magnitudes for 2021-22 between the two meetings as follows:

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                       Projections by the MPC for 2021-22
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                                     19th November           14th December
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GDP Growth Rate (%)                  4-5% tilted to the          Upper end
                                     upside                    of 4 to 5% 
Current Account Deficit (% of GDP)   Modestly exceed                 4% of
                                     2 to 3% of GDP                    GDP
Fiscal Deficit (% of GDP)            Risk of a higher                   No
                                     than planned primary       Projection
                                     fiscal deficit                       
Rate of Inflation (%)                Upside risks to      Average 9 to 11%
                                     inflation forecast        during this
                                     of 7 to 9%                fiscal year
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Two big changes in the projections can be observed. First, the expectation of the MPC in October was that the current account deficit would modestly exceed 2 to 3 percent of the GDP. This has now been raised to 4 percent of the GDP. Second, the average rate of inflation in the CPI was indicated in the October meeting as being on the upside of 7 to 9 percent on average monthly in 2021-22. There has been a big jump of 2 percentage points and the projection now for the year is 9 to 11 percent.

The projected magnitudes of two other key macroeconomic variables have remained unchanged. The GDP growth rate in 2021-22 is expected to be tilted to the upside of 4 to 5 percent. According to the November MPC, there is a risk of a higher than planned primary fiscal deficit in 2021-22.

The motivation for the above-mentioned changes clearly lies in the outcome in November. The rate of inflation jumped up to 11.5 percent, compared to 9.2 percent in October. Similarly, the trade deficit increased to $5 billion in November as compared to an average monthly of $ 3.9 billion in the previous four months. Consequently, the current account deficit is likely to have risen to $2 billion or more in November from an average of $1.3 billion monthly from July to October.

There is need to examine the validity of the latest MPC projections for 2021-22. The five monthly cumulative current account deficit is likely to be on the upside of $7 billion. At this rate, the annual deficit could approach $17 billion. This implies that it could exceed 5 percent of the GDP.

The MPC has projected the deficit at 4 percent of the GDP. Does this imply that further moves will be required on the policy front to keep the current account deficit at close to 4 percent of the GDP? If so, there could be further upward pressure on the policy rate.

The jump in the inflationary expectations to the average in the range of 9 to 11 percent in 2021-22 implies that the double-digit rate attained in November is likely to persist for the rest of the year. The risk is that it may even exceed 11.5 percent in one or more of the coming months.

The optimism of the MPC on the likelihood of the GDP growth rate being on the upside of 4 to 5 percent is based on high crop outputs, especially of cotton, jump in petroleum sales, big increase in electricity consumption, etc. However, there a number of indicators which question the basis for this optimism.

First, the recently released estimates of the Quantum Index of Manufacturing (QIM) are somewhat depressing. The growth rate achieved in the first four months of 2021-22 is only 3.6 percent. In fact, there has been a decline in output in October of over 1 percent. Over half the growth is due to the buoyancy of only one sector: automobiles. Key sectors like textiles, cement, chemicals and fertilizer are showing either negative or only marginally positive growth rates. Achieving the annual GDP growth rate of near 5 percent requires a buoyant large-scale manufacturing sector in 2021-22 with a growth rate of 6 percent or more. This now appears highly unlikely, especially given the large quantum of industrial gas load-shedding in the ongoing winter months.

Second, the Rabi crops, especially wheat, are likely to have been adversely affected by a jump in fertilizer prices and localized shortages. The price of urea has gone up by 11 percent, while its availability was down by over 8 percent, and the price of DAP has doubled. Third, construction activity also appears to have slowed down. Overall, the GDP growth rate is likely to be in the range of 3.5 to 4 percent in 2021-22, especially in light of the big negative impact on private investment of rising interest rates and the over 20 percent cut in development spending.

The MPC’s assessment that the primary deficit will be larger than planned appears to be a valid statement. The target was a small primary deficit of 0.6 percent of the GDP in the on-going fiscal year. However, there is likely to be a shortfall in revenues from the petroleum levy of over Rs 300 billion, even after the announced path of monthly increases. The GIDC could also yield Rs 100 billion less. FBR revenues are likely to be about Rs300 billion above target, especially after the broadening of the sales tax base and higher rates.

Current expenditure could be significantly above target due to higher cost of domestic debt servicing of almost Rs 250 billion following the hike in interest rates and in external debt servicing because of the faster depreciation in the value of the rupee. Further, the Provincial Governments are likely to generate a cash surplus which is at least Rs 200 billion below the targeted level of Rs 570 billion.

Overall, the consolidated fiscal deficit is likely to be Rs 550 billion above the target, close to 1 percent of the GDP. This will raise the level of aggregate demand and put pressure on the current account deficit. Consequently, this is another reason why the SBP will have to maintain an aggressive posture of monetary policy.

The remaining months of 2021-22 are clouded by uncertainty about the developments in the global economy and in the economy of Pakistan. We hope and pray that the GDP growth rate does not plummet too much, while the inflation does not rise to a persistent high double-digit rate. In effect, there is the risk of the economy going back to a state of ‘stagflation’, while foreign exchange reserves remain under pressure.

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

Copyright Business Recorder, 2021