'Economy will witness low economic growth, high double-digit inflation'

There is a serious threat that Pakistan economy could get entrenched into a prolonged and deep stagflation unless decisive and concerted action is taken by policy makers according to the Monetary Policy Viewpoint released here on Tuesday by the Pakistan Institute of Development Economics (PIDE).
It states that there are clear signs that at least in the foreseeable future the economy will witness low economic growth and high double-digit inflation - the classical characteristics of an economy in stagflation. Therefore, the real challenge is to draw up a co-ordinate strategic response to break out of stagflation by rekindling growth and checking inflation.
PIDE reviews the latest State Bank of Pakistan (SBP)'s Monetary Policy statement issued on September 29, 2010 and is critical of its action to raise the interest rate by 50 basis points to 13.5 percent. PIDE argues that in Pakistan monetary policy actions transmit their effects on macroeconomic variables with a considerable lag and with a high degree of volatility and uncertainty. The current monetary policy stance is silent about the issues of lags and the pass-through effect of the policy rate to inflation.
PIDE's Viewpoint shows that based on close analysis and earlier studies, that rising interest rate in recent years have had little impact on dampening inflation and conclude that there is no reason to believe that the situation has now changed.
In fact the increase in interest rate would increase interest payments on government debt which will cause an even higher fiscal deficit even if we take into account higher profits of the State Bank. The truth according to PIDE is that the government is borrowing beyond the agreed level from the SBP, and the SBP is not able to restrain this level of borrowing.
Borrowing from the SBP injects liquidity in the system through increased currency in circulation. The impact therefore, of a tight monetary policy stance is diluted with this automatic creation of money, which increases the money supply. The fact is that easy recourse to increased borrowings from the SBP leaves little incentive to the government to put its badly needed fiscal situation in order. The real hit of high interest rate according to PIDE is being taken by the private sector. Higher interest rate increases the cost of borrowing of the private sector, which discourages the demand for private sector credit. When the demand for private sector credit decreases, the level of private investment falls, which adversely affects prospects of economic growth.
PIDE's viewpoint is fully supportive of the SBP's emphasis on government putting its fiscal house in order. However, what is equally clear according to PIDE is that a tight monetary policy stance through increase in the discount rate serves little purpose in the current conditions. What is needed is an integrated fiscal-cum-monetary response, which brings about macroeconomic stability and helps spur much needed growth into the economy. Also fiscal reforms are easier to undertake and yield desired results in a growth promoting rather than a depressed economic environment.-PR