EDITORIAL: Monetary Policy Statement (MPS) is to be announced tomorrow. Analysts are expecting the policy rate to be maintained at 7 percent. According to a survey conducted by an association, 97 percent of respondents expect no change while 3 percent are eyeing a 25 basis points (bps) increase. Another survey conducted by another firm has claimed that 73 percent respondents (out of 78 participants) expect no change while 13 percent expect 25 bps increase, and interestingly 12 percent hold the view for a 25-50 bps decrease. The movement in bond and money market yields, in the last few weeks also suggests that the market has priced-in a no change in the monetary policy. By the time of the last policy review, the sentiment was building up for a rate hike. The stance was based on expected increase in electricity tariffs, new taxes in the upcoming budget, and overall increase in global commodities’ prices. However, with the new Finance Minister at the helm, it is becoming evident that containing inflation and boosting growth are his two top priorities. Thus, new taxes and an upward revision in electricity prices are going out of the equation. That has changed the sentiment.
Nonetheless, inflation is a serious concern. National Consumer Price Index (NCPI) was in double digits in April and is likely to remain at 10 to 12 percent in the remaining two months. State Bank of Pakistan (SBP) has maintained policy of negative real interest rates ever since the policy rate was reduced to 7 percent in June last year. The headline inflation in FY21 will arrive close to 9 percent. The justification for negative real rates is to combat the economic slowdown due to Covid-19. And one of the reasons for the doves to dominate in upcoming review is the rising number of Covid-19 cases in the last couple of months.
An accommodating monetary policy is very much in line with central banks’ policies globally. Inflation in the US is picking up, but the Fed thinks that still there is slack in the economy and inflationary pressures may prove shortlived. The State Bank of Pakistan (SBP) has an identical view. It is targeting medium-term inflation target of 5-7 percent and the objective of monetary policy is to get there. Recent inflation uptick is due to the supply side problems. The price of global commodities are moving up and that is adversely affecting the food prices at home. Since the government is not passing on the impact of higher oil prices to consumers, there is no inflationary pressure due to higher oil prices to-date. Usually, SBP looks at demand side factors along with headline inflation in making decisions. One cannot solely rely on core as non-core (food and oil) is almost half of the CPI basket. Central banks keep a close eye on output gap and wages. The output gap in Pakistan is still negative, according to SBP. This implies that economic production capacity is higher than actual production. This has allowed room to carry out an accommodating policy.
A crude way to analyse Pakistan’s potential output is to examine the GDP growth numbers. If the growth continues to be on the lower side compared to the past when the deficits in fiscal and current accounts were manageable, a slack in the economy will persist. In Pakistan, during 2013-15, GDP growth was around 4 percent while twin deficits were under control. This implies if GDP growth remains at or under 4 percent, output gap may remain negative. Interestingly, FY21 GDP growth is estimated at 3.94 percent and if the trajectory inches towards 5 percent over the next fiscal, the output gap may turn positive and that may warrant some tightening.
The other important factor is real wages, which have been falling for the past two years. All eyes are on the budget this year. If the federal and provincial governments increase salaries of their employees, private sector will have to follow suit raising fears of a wage price spiral. Third important factor is international oil prices. In the last monetary policy minutes, it was categorically stated that if oil prices stay high, the committee might have to raise policy rates to bring inflation back to medium-term target range. Oil prices are not coming down. Wages are likely to increase in fiscal year 2021-22. The growth momentum is clearly building up and that may turn output gap into positive. The current account (C/A) may slip too. Keeping this in view, some tightening in FY22 is very much on the cards. But as SBP clearly stated in the previous two policy statements, any increase (if needed) will be measured and gradual. It is important to see what forward guidance is offered this time around to give an indication of future course.
Copyright Business Recorder, 2021
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