Monetary policy statement

EDITORIAL: The decision to keep the discount rate unchanged at 7 percent by the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) was widely expected for one reason and one reason alone: the government’s desire to maintain the present accommodative monetary and fiscal policies for a higher growth trajectory particularly when the fourth wave of the Covid-19 pandemic is threatening to wreak havoc on the lives and livelihoods of the people.

Theoretically, the economic rationale for a raise in the discount rate exists based on the inflation data released by the Pakistan Bureau of Statistics (PBS) for June 2021: Consumer Price Index (CPI) at 9.7 percent – an index to which the SBP in recent times, unlike its historical practice, linked the discount rate from May 2019 till March 2020 (the onset of Covid-19). Core inflation, non-food and non-energy, calculated for June 2021 by Pakistan Bureau of Statistics (PBS) increased by 6.7 percent year on year compared to 6.8 percent in May 2021 and 6.5 percent in June 2020. The usual practice has been to set the discount rate at least 100 basis points higher than core inflation. It is, however, relevant to note that this decision by the MPC was perhaps possible as the sixth International Monetary Fund (IMF) review was deferred till September and as per the Ministry of Finance the internal exercise of recalibration of time-bound conditions and structural benchmarks agreed in February 2021 is not yet complete. In the event that the sixth review talks are conclusive in September the discount rate may have to be raised, unless there is an unexpected significant decline in core inflation.

Given the linkage of the discount rate to inflation - be it CPI or core - it is not surprising that the Monetary Policy Statement (MPS) focused on this macroeconomic indicator above all others and projects it at 7 to 9 percent for the current year (a rounding up given the budgeted target of 8.2 percent). The MPC also gave credit to the ‘government’s administrative measures and imports of wheat and sugar’ for the fall in inflation in June 2021; however, it ignored the addition of a graph by the PBS in the calculation of the sensitive price index (SPI) titled 'Utility store and open market comparison' which showed an average price per unit differential between the two at 1128 to 800 – a discrepancy met with higher subsidies which raises the budget deficit – a highly inflationary policy.

The MPC held supply-side factors responsible for inflation and added that a key risk that could lower inflation is resurgence in the pandemic (though earlier the statement notes that uncertainty has been created by the ongoing fourth Covid-19 wave in Pakistan). Risks that could raise inflation as per the MPC are external to the SBP - higher than expected global commodity prices (though no mention is made of the eroding rupee) especially if coupled with upward adjustments in petroleum levy or domestic energy tariffs as well as fiscal slippages or stronger demand side pressures. Energy sector experts dispute the MPC assertion that “headline inflation should begin to dissipate more visibly in the second half of the year when the February electricity tariff increase drops out of the base”. This view of the MPC is in consonance with a decision announced by finance minister Shaukat Tarin soon after he was appointed- “converging to the 5 – 7 percent target range over the medium term” with the two percentage range too wide and the medium term has not been quantified. The MPC does, however, rightly notes that government decisions and external factors rather than monetary policy measures would be responsible for any rise in inflation.

The MPC skipped any mention of the criticality of the success of the sixth review nor the reliance on debt equity and borrowing that accounts for over 50 percent of the current foreign exchange reserves but noted that Pakistan’s external financing needs of around 20 billion dollars would be ‘more than fully met in the current year’ due to ‘contained current account deficit and healthy commercial, official, portfolio and FDI inflows.’ This, in our view, is a valid observation and should hold provided that the suspended IMF programme resumes based on the scheduled review in September. The MPC has further noted that in the event of an unforeseen shock, higher than expected oil prices or capital flight from emerging markets due to tightening of financial conditions in advanced economies, the market- based flexible exchange rate would help keep the balance of payment position sustainable. The rupee value has eroded from 152 to a US dollar, the average in May 2021, to over 161 in the interbank market, and this would impact on the budget deficit which unless checked would impact the monetary stance because of an increase in inflation.

As the MPS notes, that the factors responsible for the ongoing inflation are exogenous and/or are due to fiscal decisions/slippages, in that case the SBP would be hard pressed to maintain the present accommodative monetary stance as the discount rate and the rupee would come under increased pressure if these factors persist.