The monetary policy committee is meeting next Monday. In the last review, two out of ten members voted for a rate cut of 100 basis points (bps), leading to a split decision. This reflects the sentiments of the market participants, who are split over ‘when’ to start easing.
The CPI reading is expected to be at around 17-18 percent in April from 28.3 percent in January 2024. The ten percentage points decline in three months warrants some easing. The case becomes more compelling as the forecast for the next twelve-month inflation is at 15-17 percent.
With the policy rate at 22 percent, the real interest rates turned positive on spot basis in March (CPI at 20.7 percent) and will be well within positive territory for April estimates, and on forward looking basis. The monetary policy is significantly tight now. The same is the case of fiscal policy where the primary surplus stood at 1.7 percent in 1HFY24.
The tightening of both monetary and fiscal policies is yielding results causing a buildup of disinflationary trend – especially in non-perishable food commodities. Global commodity prices are coming down, and with stable currency amid falling demand, the decline is visible in Pak Rupee pricing now.
On the other hand, demand keeps falling. The economy is dead cold. We are in second consecutive year of low (or negative) growth, and the situation is not likely to improve soon. The current account is almost in balance, and the deficit is likely to remain near zero till growth is revived. However, given the precarious financial and capital accounts within the balance of payment (BoP), the country simply cannot afford a modest current account deficit, unless foreign investment is revived.
Thus, it is critical to not turn the tap on expansionary fiscal or monetary policies. If demand starts reviving, the imports are bound to rise, and the currency would invariably come under pressure, and inflationary expectations will be at a risk of becoming unanchored again, as was the case for the last 12-24 months.
Thus, it’s prudent to keep the real rates positive till the inflationary risks are completely subsided and SBP’s so-called medium-term target of 5-7 percent inflation is in sight.
Another perspective is that since SBP had remained behind the curve in tightening, it should compensate for the slack.For example, SBP was not proactive in 2HFY22 when inflationary pressures were building while the fiscal policy was expansionary. The inertia resulted in historic high inflation in Pakistan, and to counter these pressures, SBP must keep real rates become substantially positive and inflation forecasts return to SBP’s target range.
Having said that, keeping real rates positive on a forward basis doesn’t mean that there is no room for cutting the nominal rates. The question is when to start easing and by how much quantum. SBP should gauge the risks very carefully.
One risk is about uncertainty in the inflation outlook, both SBP and analysts’ community were far off in forecasting inflation in FY23. Then, there are geopolitical risks as the possible escalation in the Middle East can push oil prices up, and its direct and indirect impact can result in higher inflation at home. The other risk concerns the next IMF programme and the impact of IMF’s programme conditions on inflation. And the biggest risk is of energy pricing in Pakistan where authorities and IMF have failed to present an alternate to repeated price hikes to curb circular debt flow.
The SBP should tread with care, lest the risks are unraveled, and should carefully review the upcoming budget, as continuation of tightening fiscal policy is imperative before monetary easing may begin.
At the same time, SBP should evaluate whether it is a case of over-tightening, as overdose of medication has its own implications for the overall health of the economy. Stagflation can erode confidence in macroeconomic in devastating ways. Unemployment is on the rise. Private credit growth is in negative. Moreover, high rates are showing early signs of rising bad loans in the private sector, especially in textile.
The higher interest rates also have a bearing on the fiscal side where the federal government’s hands are tight in further curtailing the expenditure in the short term without passing some responsibility to the provinces. The money printed due to reverse open market operations is directly linked to the higher rates – as it is fiscal financing that counts in the short term while primary balance has medium-term implications.
Then the benefit of higher rates is helping banks and wealthy savers while cost of government debt is being spread over entire population.
Based on these factors, SBP should start easing in the upcoming meeting. Cutting rates by 100 bps could be a good start, and keep on lowering the rates, as data becomes more visible, going forward.
Copyright Business Recorder, 2024
Ali Khizar is the Director of Research at Business Recorder. His Twitter handle is @AliKhizar
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