State Bank of Pakistan (SBP) is now becoming predicable in its surprises. Right after the announcement of IMF revised world outlook, SBP came up with another surprise cut. However, the prime reason for meeting in June (against scheduled meeting in July)is for private sector borrowers to take advantage of repricing of loans - Rs3.3 trillion are to be repriced in July.
The other reason for doing thisnow (and maybenot a week ago) is to ensure that foreign inflows are plugged in, and there is less (or no) pressure on currency due to rate cut. Remember, there is always a tradeoff between interest rates and currency. Businesspersons should read this before advocating for another cut.
Enough is enough. The SBP should take a pause now. Any further rate cut could be counter-productive. It is not indicating any further easing.
In earlier moves, Monetary Policy Statement (MPS) was clearly saying that SBP is ready for further action. Plus, the SBP has said that on forward looking basis, real interest is close to zero. SBP said the same in April too. This means that there could be a revision in inflation outlook. Its last stated policy is at inflation of 7-9 percent.
Market pundits are expecting inflation now at 5-7 percent. There seems to be no signs of further fall in inflation outlook.
But we have to keep in mind that this is a response to health crisis. That health crisis has created an economic mess. The health crisis is nowhere close to over, much like the economic crisis. The market is expecting (or demanding) another rate cut of 1 percent. Let's see how SBP takes it. Doctor's order is to take a pause.
The policy rateis now close to historic bottom. There will be some increase in import demand due to low rates. Not all the imports are going to be aimed at capital expenditure or expansion of industries. Rather, most of the demand is to fill in the private sector capacity. Automobile sector is to benefit the most.
The auto finance consumer demand is likely to pick up. This will have some pressure on imports. Similarly, other consumption-based imported demand may pick up too.
It would naturally respond with the pick in imports through exchange rate adjustment. That is why the tradeoff is very important. Pakistan's economy is largely deleveraged and exchange rate has a bigger impact than easing of the monetary policy. But at this point, the pressure on interest rate reduction was huge on monetary policy committee.
Nonetheless, the currency should not be under pressure in the next few weeks or months. Till the time imports pick up (or current account deficit widens), currency will remain stable and may appreciate. The currency was falling for the past two months and it reached its all-time low earlier this week. The reserves were falling despite attaining current account surplus in May.
The issue was in financial/capital accounts. The debt repayments were due and no money was funneling in to stop the reserve fall. Seeing that, currency fell under pressure and the SBP did not intervene. The central bank knew that when the expected flows are in, currency will pull back. It started pulling back in the last two sessions. Some more flows are expected in June.
Reserves are likely to cross $12 billion mark soon. In a telephonic conversation, SBP Governor Dr Reza Baqir has reportedly said: "We are comfortable at external side on full-year basis. With recent and expected inflows, we are reasonably assured on external front".
Seeing the reserves building, better inflation outlook and weakened currency, the infamous portfolio investment (hot money) may start coming in again. There are signs of this happening. The portfolio investors do simple calculation. They see real interest rates and currency movements before making a bet.
If these flows come in again, that would break the myth that interest rates were kept at 13.25 percent to attract this money. The reasons are economic. Unfortunately, our businessmen and TV commentators do not appreciate the economic principles and rely instead on conspiracy theories.
Now it's time to think rationally. Respect economics. Understand tradeoffs. Appreciate market-based foreign flows. And those who were saying that high rates were impeding investment,time to prove yourselves. Invest in capital expenditure.
What we have seen is there were no (or little) capital expansion (apart from cement/steel) in the last cycle of low rates. The economy has structural issues, and investment may not be possible without resolving these. Not even at zero percent rates (keep dreaming).
Copyright Business Recorder, 2020
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