Notwithstanding the number of hours spent reading, the logic and objectives of monetary policy decisions have largely remained inexplicable and dare one say, illogical; albeit this does not mean all other economic theories make perfect sense.
For instance, what compelled the central bank to raise the policy target rate by 5.25% in one year remain largely inexplicable; at the beginning of the year this rate stood at 5.75% and we began the New Year at a wholesome 10%, Happy New Year! And remember, before January 2018, the rate was kept constant at 5.75% for 19 months.
The Monetary Policy Statement (MPS) of January 2018 started with positivity that economic growth was on target to achieve the highest level in 11 years and that inflation while currently at 3.8% was likely to grow within a target of 6% by the end of the year. Astonishingly, with everything going as planned, the policy rate was increased by 25bps, giving the argument that this was necessary to pre-empt overheating of the economy and inflation breaching its target. Go figure!
The MPS of November 2018 asserted that headline CPI inflation was 5.9%, within the targeted 6%; albeit no idea how and why the target was 6%. SBP goes on to project that inflation will not increase beyond 6.75% for FY19; worrying but perhaps not very much. The GDP growth for 2019 was projected at slightly above 4%, definitely no overheating here. Nonetheless, the rate was increased by 150 bps!
The top argument given in the MPS for the increase in the policy rate had to do with checking continued inflationary pressure. But was not inflation within the target and projected to grow by only 0.75%? Curiously, during the last 12 months inflation increased by 2.1% while the policy rate was jacked up by 5.25%; imagine where inflation would be otherwise! But was not SBP always pointing out that the fall in inflation had to do with decrease in oil prices and in fact continues to believe that inflation is linked with oil prices, and expresses this belief in the MPS, "Although the recent decline in international oil prices could potentially play a positive role in slowing down the current inflation trajectory..". If oil prices are the reason inflation rises and falls in Pakistan, than why fiddle with the interest rates, especially when oil prices are falling.
But classic is the strategy given in the MPS for controlling inflation, "the adoption of a flexible inflation targeting framework will help anchor inflation expectations". What exactly is the framework for flexible inflation targeting, even if we figure out what that means, and what should be the inflation expectations at? And when thinking about the framework, don't forget that everybody believes that the size of the informal economy is at least as big as the formal economy and only around 16% of the population have access to, or want access to, bank accounts.
And how do higher interest rates assist in the battle against the twin deficits; the third development which spurred the SBP into action to further consolidate by increasing interest rates to ensure macroeconomic stability. The second development given in the MPS, low real interest rates, by the way is ultimately more confusing; firstly the real interest rate was around 2% in January 2018 compared with 2.6% in November 2018, so why was the policy rate increase lesser back then?! Secondly, real interest rates are for the rich!
Trade deficits are the reason we have a current account deficit, and tariff hikes are the only mechanism whereby that deficit can be controlled; rupee depreciation and interest rates are largely helpless in this particular objective. As regards the fiscal deficit, higher interest rates are more than likely to increase the deficit because of higher debt servicing; arguably the reason why fiscal management team wants stable interest rates and a strong rupee. Considering that the rupee has been significantly depreciated, interest rates are up and tax collection is down how fiscal policy will play a supportive role to generate conditions for a sustainable growth path remains a mystery.
As stated in the beginning, the chances of us, the laymen, building a rocket are much brighter than us ever understanding monetary policy. Funnily enough most all of us still believe that money supply has to do with SBP printing money. In the modern world, creation of money is a keystroke away for banks; debit loans and credit deposits. This essentially suggests that demand for capital by private sector is not constrained by supply of money. Albeit, higher interest rates, other than market driven, will drive away demand, which should be worrying for a country starving for capital investment. At 10%, the chances of entrepreneurs risking investment in manufacturing projects which can take 3 to 4 years for achieving commercial operation at a minimum are not very bright.
But, prima facie, those in the know should know better. And in the absence of complete information it is best to defer to those who know; common sense is not sufficient to build a rocket. So sit back in your easy chair, with your sandwich, and watch the expert analysts criticise the government on the idiot box for its failure to spur economic growth despite being assisted by a congenial environment of rising interest.
(The writer is a chartered accountant based in Islamabad. Email: [email protected])
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