MPS — The challenges ahead

The Monetary Policy Committee (MPC) has kept the policy rate steady at 7 percent. The Monetary Policy Statement (MPS) issued by it has clearly stated that State Bank of Pakistan (SBP) intends to provide future direction through its forward guidance on monetary policy.

For the current fiscal year, SBP is projecting a growth rate of above 2 percent due to improved economic conditions. The MPS does provide a note of caution to the market about the possible upside inflationary risks, which is obvious due to rising global oil prices that will further depend on the domestic food/commodity prices, which skyrocketed in 2020.

Wheat, sugar, energy and cotton are surely fiscal issues that need to be addressed by the government. Price stabilization mechanisms of major crops need to improve. Cotton output fell to 2-decade low due to lack of technology transformation and poor quality of seeds. All are directly costing the exchequer in a sizable amount.

Covid-19 has caused a variety of unprecedented global challenges. I, therefore, support MPC’s observation as it is extremely difficult to predict the reshaping of the economic landscape due to the pandemic. Both the fiscal and monetary managers are required to frequently revisit and reconsider their policies and strategies.

With the International Monetary Fund’s (IMF’s) temporary fast-track Rapid Financing Instrument (RFI) support, the measures taken by SBP through its Temporary Economic Refinance Facility (TERF), which is a concessionary refinance facility scheme, the economy has responded positively as stability is quite visible. In uncertain times, TERF is the key driving factor for the economy, therefore, any reduction or untimely withdrawal of stimulus will have an adverse impact on growth.

About inflation, the primary objective of SBP should be the price stability. A check on inflation will contribute towards economic growth and bring about financial stability.

Hopefully, with extended fiscal and monetary support, the recovery process will not be short lived. For the continuation of stable economic conditions, the real challenge for the central bank will be to constantly provide strong monetary stimuli.

In my view, the major focus of MPC has been on its existing accommodative stance of monetary policy and due to ongoing pandemic threat, SBP will facilitate its policy guidelines through forward guidance on monetary policy. It clearly gives hints that SBP has no plans to hike rates in immediate to near future. Instead, it is an easy policy stance in a slow growth environment. An accommodative policy is a measure to boost money supply (M2) with a view to fuelling the economy.

This also became necessary due to excessive move in bond yields. Fixed income market traders were talking of a 150 to 250 basis points hike in the next fiscal year without realizing the market consequences and increased debtedness of the country. The 10-year bond yield shot up by nearly 70 basis points in a couple of months.

Furthermore, MPS lays emphasis on policy setting, which will remain unchanged in near term.

Policymakers are aware of the fact that a rate hike or even talk of any rate hike in medium term (6 to 12 months) could badly hurt the ongoing progress since SBP sees the inflation trend in the 5-7 percentage target range in medium-term. Any increase in inflation beyond estimation can compel SBP to further slash policy rates to support the economy.

In his talk, SBP Governor Dr Reza Baqir said that bank deposits increased significantly, hinting that there is ample of liquidity in the banking system.

But the SBP data shows that commercial banks, deposits/advances have further plunged to 47.53%, which is probably the lowest in the world.

The increase could be due to government’s decision of placing funds with banks to meet debt obligations. There is a need for keeping an eye on the M2 data, which is gradually picking up. Excessive M2 could create inflationary pressures. It could be because of cash flow accounting as sizable T/bills and bonds are maturing.

The ongoing growth market talk may temporarily sound very exciting. In my view, the most important step towards boosting growth will be access to easy/cheap funding. Without sufficient liquidity, the economy will never make a comeback.

For the sake of reallocation of efficient capital, de-clogging of banks’ balance sheets is the prerequisite condition. Without liquidation of stressed assets to half and shifting of funds to banks’ lending portfolios (Bank’s GOP Holdings of Rs 9.655 trillion versus banks’ advances of R 8.5 trillion), the economy will not be able to flourish and gather momentum at the required pace.

No economy can prosper without targeted bank lending. This is why FED’s asset size has reached $ 7.2 trillion. And yet the US market is desperately waiting for a USD 1.9 trillion economic stimulus package.

(The writer is former Country Treasurer of Chase Manhattan Bank)

Copyright Business Recorder, 2021