Restoring investor confidence key challenge

Taming the inflation monster is turning out to be a challenge at a time when many analysts were expecting the inflation to be in control due to the restoration of the IMF (International Monetary Fund) relations, ending of the high base effect and possible softening of the global commodity prices. They are now revising their models on the spreadsheet.

SBP’s (State Bank of Pakistan’s) medium -term inflation target of 5-7 percent is as elusive today as it has been for the past three years. The buzz is that another 2 percent increase in the policy rate is due before the tightening cycle concludes – expect half of it (1 percent increase) today.

The key challenge is restoration of investor confidence. And in its absence, the dollarization continues. This along with a surge in the global commodity prices (such as oil and grains) due to better than expected global (mainly the US) economic recovery is keeping the inflation challenge very much alive.

Then the IMF was very much critical of the SBP for not being proactive in managing inflation through timely tightening and resulting in even higher inflation.

The question is how to revive the investor confidence. The IMF has given a lifeline to the ailing economy. There are no tough conditions attached to the current SBA (Stand-By Arrangement). Still confidence is at a low ebb.

The stability of the system is missing. Private investors and the business community are not entirely convinced of the soundness of state’s plan for billions of dollars of investment and selling of assets to GCC state-owned companies. The involvement of the private sector is missing.

The underlying competitive environment keeps eroding. And that cannot be improved without carrying out meaningful economic reforms. Unfortunately, however, nothing is happening on that front – neither by the state nor by the IMF.

The IMF’s report is tough, and the underlying tone is negative which is suggestive of similar sentiments of the IMF staff. The frustration of the writers is very much visible from the language. However, the absence of loaded conditions and benchmarks depicts the soft stance at the board level.

All what the IMF is asking for is a market-based exchange rate with clear continuous benchmark of not allowing the open market rate deviating from the interbank rate. Then the condition of keeping the energy circular debt growth in check by power tariff revision is another important inherent benchmark.

And the positive trigger could have been that the IMF has categorically said the government’s debt is sustainable on the baseline case (though the baseline is quite optimistic). This implies that in the absence of any fiscal misadventure, the debt is sustainable, as per the IMF.

The stock market boom is reflective of these assumptions. Commercial bank stocks rallied as the near future chances of domestic debt restructuring faded. Then the strictness on the circular debt growth check has boded well for the energy sector. Having said that, the skewed taxation on the already taxed sectors and passing on of all the energy sector inefficiencies on the consumers is eroding the industrial competitiveness.

The business community does not agree to the IMF recipe of solving the energy circular debt and management of supply side inflation solely through increasing interest rates. The real game changer could be coming up with tax reforms in the real sense and curbing the energy circular debt by dealing with transmission and distribution inefficiencies and growth in energy consumption.

However, what is happening is the exact opposite. Power consumption is falling, which is pushing the capacity charge higher as the production capacity is enhancing.

Having said that, the situation is certainly better than before. The key is to capitalize the lifeline by carrying out reforms. However, it is not easy – especially when those in control do not have mass public support. That is making the task of instilling reforms even more challenging. The investors desire stability and a clear roadmap ahead. That is simply missing.

Then the kind of roller coaster ride the economy had in the last year or so has its bearing. The massive currency depreciation and wealth erosion have a lasting impact on the investors and business community. There is no crazy buying of foreign currency now; but those who are married to dollars are not looking to convert to PKR. Most are following the wait-and-see policy.

If there is going to be stability in the next few months, the situation can improve. Otherwise, it’s a matter of time before the authorities deviate from optimistic baseline debt sustainability scenario.

Copyright Business Recorder, 2023