Economy: Demystifying some policy choices

In a recent blog article ‘War dims global economic outlook as inflation accelerates’ published by the International Monetary Fund (IMF), it was pointed out that due to war in Ukraine, inflation was likely to remain high for longer period of time, whereby the article indicated that ‘Inflation has become a clear and present danger for many countries.

Even prior to the war, it surged on the back of soaring commodity prices and supply-demand imbalances. Many central banks, such as the Federal Reserve, had already moved toward tightening monetary policy. War-related disruptions amplify those pressures. We now project inflation will remain elevated for much longer.’

Yet the writer believes that it is happening not just because of the war, but also because rather than understanding the limits of fiscal and monetary policy being reached in developing countries for many months now, and providing them needed level of financing — where last December, UNCTAD put the number at around $2 to $3 trillion – along with enabling them to create much-needed fiscal space through debt moratorium/debt relief, and pushing them towards pro-cyclical policies, when, in addition to financial support, they needed counter-cyclical policies to control inflation and reached sustained economic growth momentum.

Moreover, the IMF was slow to respond to the financing needs of countries, where after almost one-a-half-year later since the pandemic started that is in last August that it provided enhanced SDR allocation. Having said that, by allocating on the principle of quota of a particular country, depending on how much a particular country contributed to the pool of IMF resources, therefore, rich countries received a lion’s share of this enhanced allocation of $650 billion.

This was strange, to say the least, since it was the poor developing countries that needed most financing. More recently, the IMF has created the Resilience and Sustainability Trust (RST), which provides a window through which rich countries could transfer those enhanced allocations, as either loans or donations, to developing countries. These transfers should be made at the earliest possible, and hopefully as donations, given the serious macroeconomic, growth/stimulus challenges facing developing countries.

An April 2022 IMF policy paper ‘Proposal to establish a resilience and sustainability trust’, which was reportedly approved by IMF Executive Board during this year’s IMF Spring Meetings, gives details on RST as follows: ‘The Executive Board of the International Monetary Fund (IMF) approved the establishment of the Resilience and Sustainability Trust (RST) to help countries build resilience to external shocks and ensure sustainable growth, contributing to their long-term balance of payments stability.

The RST will complement the IMF’s existing lending toolkit by focusing on longer-term structural challenges — including climate change and pandemic preparedness — that entail significant macroeconomic risks and where policy solutions have a strong global public good nature. About three quarters of the IMF’s membership will be eligible for longer-term affordable financing from the RST, including all low-income countries, all developing and vulnerable small states, and lower middle-income countries.’

The importance of proper allocation of SDRs to developing countries, in terms of reducing their debt burden – and the benefits it could bring in terms of foreign exchange reserves, exchange rate, level of imported inflation, and overall balance of payments – and the need now of correct and timely relocation of last August’s enhanced SDR allocation — could be understood from a recent study ‘Special drawing rights: the right tool to use to respond to the pandemic and other challenges’ by Kevin Cashman, Andres Arauz, and Lara Merling, and published by Center for Economic and Policy Research (CEPR).

Hence, this Report pointed out in this regard: ‘As of mid-March 2022, the IMF reports that the total outstanding loans for 94 countries, including Poverty Reduction and Growth Trust (PRGT) loans, amount to $145 billion. This is roughly equivalent to a third of the SDRs recently allocated to advanced economies, or a quarter of these countries’ current SDR holdings. Hypothetically, rich countries could donate just 25 percent of their SDRs and provide complete relief in terms of debt owed to the IMF.

After this, advanced economies would still have approximately $270 billion more reserves than before the SDR allocation. Of course, this reduction of reserves for the high-income countries would have virtually no impact on them: first, because they would not convert these SDRs to hard currency or use them for budget support; and second, the fact that markets know that they will not be used would tend to negate their economic impact as reserves.’

At the same time, while financing and debt relief remains limited for developing countries, they have also been asked to practice austerity and pro-cyclical policies. According to Oxfam, during the last two years, 87 per cent of the IMF programmes called for adopting austerity measures, which is strange not only because pandemic called for counter-cyclical policies as a matter of rational thinking, double standards seemed to be adopted on the part of the IMF, which reported asked many rich, advanced countries to provide stimulus during the pandemic.

Pro-cyclical policies — reduce subsidies, increase taxes, and raise policy rate — during the pandemic, will most probably, not only not allow reduction in in inflation, but rather stoke it since the inflation currently — at the back of global commodity supply shock, and which has been accentuated by the war in Ukraine by Russia-is primarily supply-driven, cost-push inflation with a high component of imported inflation, and decreasing subsidies, especially on oil in the case of net oil importing countries like Pakistan, will contribute to inflation.

The extent of impact of food inflation could be gauged from the fact that it showed increase that was not seen in more than a decade, as pointed out by an April 8 Financial Times (FT) published article ‘World food prices hit new record on impact from Ukraine war’. As per the article, ‘Global food prices have struck a new high, soaring at the fastest monthly rate in 14 years after the war in Ukraine hit the supply of grains and vegetable oils, in a shift likely to do the greatest harm in poorer countries around the world. March’s food price index from the UN Food and Agriculture Organization rose to its third record high in a row, jumping 34 per cent from the same time last year…’.

At the same time, pursuing the policy of raising policy rate, and the strategy of keeping it even more than the inflation rate — where currently the real interest is only slightly negative, since nominal policy rate is at 12.25 percent, and inflation rate at 12.7 percent — is going to push the country into a vicious cycle of interest rate chasing inflation, given inflation is primarily being determined by cost-push inflation, so rise in interest rate and keeping it at an elevated level, and in addition lack of any meaningful subsidy on oil – where crude prices are on the rise and have now crossed $110 per barrel, and only a few months ago had crossed $130 per barrel, before coming down due to some transitory effects like release of supply from inventories in the US, and lockdowns in China reducing overall oil demand – would only lead to rise in inflation, and not the other way round.

So, in this sense also, pro-cyclical policy will only backfire with regard to reducing inflation through adopting tight monetary policy, and therefore, policy rate should be drastically reduced to at least below double digits to start with; and it must be reduced a few points more in the coming months with positive consequences in terms of debt servicing, bearing the burden of oil subsidy, and fiscal deficit.

On the other hand, unlike Pakistan, which has been aggressively raising policy rate since the start of the year, India, for instance, raised its policy rate for the first time in four years, although inflation started on a rising path since 2019. A May 4 FT published article ‘India’s central bank raises interest rates for the first time since 2018’, indicated in this regard that ‘The Reserve Bank of India announced a surprise 40 basis point interest rate increase on Wednesday, the first hike in nearly four years, in response to alarm over the surge in global inflation triggered by the Ukraine war. The RBI raised its benchmark repo rate to 4.4 per cent, up from a record low of 4 per cent left in place since rates were cut at the start of the Covid-19 pandemic in May 2020.’

While in rich, advanced countries, controlling inflation through tight monetary policy stance is more warranted, given the fact that in addition to inflation happening from high oil prices, a large level of stimulus provided led to a lot of demand recovery that was lost during the initial phase of the pandemic, so there is both cost-push and demand-pull inflationary channels at play, yet the rise in policy rate by many developed countries, including the US, has overall been seen to be excessive since inflation is actively being stoked from both channels of cost-push and demand pull, with likely cost-push inflationary consequences domestically, but with more serious consequences for developing countries, which are already struggling with their balance of payments, and higher interest rates in rich countries creating more competition of foreign portfolio investments.

For instance, the US Federal Reserve in the most recent action increased policy rate by half a percentage point in one go, which was the largest increase in one go since 2000.

A recent Bloomberg published article ‘Fed hikes rates half-point as Powell signals similar moves ahead’ pointed out in this regard: ‘The Federal Reserve delivered the biggest interest rate increase since 2000 and signalled it would keep hiking at that pace over the next couple of meetings, unleashing the most aggressive policy action in decades to combat soaring inflation.’ Renowned economist Kevin P. Gallagher tweeted on April 4 his thoughts with regard to aggressive interest rate hike as follows: ‘Aggressive rise in FED rates may (or may not) help stem price increases in US, but will accentuate developing country liquidity and debt distress.’

Similarly, in England, while the Governor of Bank of England (BoE) was quoted in an FT published article ‘Bank of England warns of UK recession this year as it lifts interest rate’ whereby he attributed the main reason behind inflation to be energy prices — a determinant of cost-push inflation – and therefore demand-pull inflation is not the main reason.

Monetary tightening stance is needed to be adopted in that context and not too much, but seven members, against two members of BoE’s Monetary Policy Committee, favoured more monetary tightening going forward, on top of the raise in policy rate just made, especially when likelihood of recession is already looming. Moreover, overboard tightening will likely cause greater competition for developing countries, many of which, including Pakistan, are already facing serious balance of payments issues.

With regard to the IMF asking Pakistan to adopt austerity and pro-cyclical stance, especially in terms of keeping policy rate high, and providing very limited subsidy on oil, and not understanding that government has reached the limits of usage of macroeconomic policy instruments, and therefore, the problem for many months now is that no significant level of SDR allocation or debt relief overall has been received by the country.

Hence, the government needs to demystify the myth that remaining in the IMF programme is a must for unlocking resources from other lenders, since leaving the programme does not mean that Pakistan is leaving being an IMF member, and all member countries are under Article IV consultations and reporting on the economy, and in quite a lot of detail with regard to both macroeconomy, and overall economy. Therefore, it does not matter if Pakistan leaves the programme in terms of receiving finance from other donors, since they will have ample insight into country’s economic performance through the lens of IMF’s Article IV reporting.

The IMF indicates with regard to the Article IV consultations as follows: ‘When a country joins the IMF, it agrees to subject its economic and financial policies to the scrutiny of the international community. …Country surveillance is an ongoing process that culminates in regular (usually annual) comprehensive consultations with individual member countries, with discussions in between as needed.

The consultations are known as “Article IV consultations” because they are required by Article IV of the IMF’s Articles of Agreement. During an Article IV consultation, an IMF team of economists visits a country to assess economic and financial developments and discuss the country’s economic and financial policies with government and central bank officials. …The team reports its findings to IMF management and then presents them for discussion to the Executive Board, which represents all of the IMF’s member countries.

A summary of the Board’s views is subsequently transmitted to the country’s government. In this way, the views of the global community and the lessons of international experience are brought to bear on national policies. Summaries of most discussions are released in Press Releases and are posted on the IMF’s web site, as are most of the country reports prepared by the staff.’

It is, therefore of utmost importance for Pakistan to immediately leave the IMF programme if the Fund does not allow it to adopt counter-cyclical and stimulus-oriented policies, given the serious negative consequences pro-cyclical policy stance has already produced for Pakistan, in terms of macroeconomic, growth, poverty, and inequality.

(The writer holds a PhD in Economics from the University of Barcelona.

He previously worked at International Monetary Fund)

He tweets @omerjaved7

Copyright Business Recorder, 2022