The monetary policy is due tomorrow; the austerity wave is expected to continue with hawks expected to dominate the monetary policy committee. If the last MPC minutes are any guide, another hike in interest rate is likely. The committee and FPAS model are finally converging to the ground realities of the economy. One may wonder if it is due to realization of the mess or the absence of PMLN government to let the members dictate.
Well, the PMLN government is history and last decision was taken under the nose of Shamshad who was gung-ho for tightening. If we take Asad on his words, the monetary and exchange rate policies are to be determined by the SBP without any influence of ministry of finance.
It is hard to imagine de-politicization of exchange rate; but in case of interest rates, the SBP may well become independent. The tone of policy would not be as hawkish as it was last time. In the last committee, five out of six members went for 100bps hike, while one voted for 150bps increase.
The first and foremost consideration for tightening is the inflationary trend. The CPI estimate is revised up to 6-7 percent from 5.5-6.5 percent and against the target of 6 percent. The actual number might be even higher as international oil prices are high with Brent trading over $80 per barrel. Now with even more sanctions on Iran from Nov 4 onwards, expect oil to rally further north. The expected rise in electricity tariffs is all set to further fuel the CPI, alongside the already announced one in the gas prices.
That is not a good omen, as higher oil price would not only result in higher inflation but will also make the job difficult for economic managers to arrest the high twin deficit - higher oil prices directly increase the current account deficit while the circular debt may increase further to disturb fiscal balance.
Core inflation had reached at 7.6 percent in August with a 12 month moving average of 6.2 percent. Should the oil prices remain high, there will be no respite to core inflation. This warrants the attention of the MPC committee. Apart from core inflation, the wholesale price index is in double digit as well which implies that the CPI is to pick up in the months to come. The question is that how much of monetary tightening is enough to subside the inflationary pressures as growth is a consideration, the SBP would have in mind. The economy is surely slowing down which is visible from number of leading indicators such as HSD consumption which is down by 31 percent year on year in Jul-Aug - sooner its impact will be visible on other growth indicators too.
Plus, the government has cut the federal PSDP by Rs225 billion from the budgeted Rs800 billion to Rs575 billion. The currency depreciation, inflation, monetary tightening and overall economic uncertainty have impact on growth. THE ADB has projected GDP growth at 4.8 percent against the 5.8 percent growth in FY18 and government target of 6.2 percent in FY19.
The core objective of interest rate hike is to curb domestic demand to curtail inflation and in the current scenario, the most important element is to curtail imported demand. The magic of austerity is already visible and too much tightening can actually be counterproductive as there is limit to import curtailment.
The monetary aggregate (M2) growth has been restricted to 9.7 percent in FY18 versus 13.7 percent in FY17 and the trend continued in the first three months of the ongoing fiscal year. How much more demand can be cut? The point is that monetary tightening can only curb demand driven inflation while it is cost push inflation that is primarily in play in Pakistan. The real interest rates are in positive territory after 150 bps hike in policy rate to 7.5 percent versus headline inflation at 5.8 percent and core inflation at 7.6 percent. Seeing just from the lens of inflation and growth mix, the need of the hour is to wait and see.
But hold your horses, the core of the economic woes in twin deficit problem with immediate concern is to curb current account deficit through curbing import demand. However, the long term macroeconomic stability including reducing CAD sustainability, the need is bring fiscal deficit under 4 percent. The deficit was around 6 percent in FY18 and it may not be much different in FY19, as at best it can be reduced to 5.5 percent, with more chances of it being around 6 percent.
The need is to work on generating more revenues and curbing inefficient spending especially on subsidies. That is easier said than done and it has nothing to do with monetary policy. Hence the efficacy of MPS to stabilize the economy is limited. Given 150 bps increase in the past two reviews, a prudent decision would be to not increase the policy rate by more than 50 bps.
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