SBP’s optimism

The recent Monetary Policy Statement by the SBP has begun to remove apprehensions about the state of the economy and in the short-run prospects. In a one-page lucid statement, the SBP has indicated that it remains positive regarding growth in the economy in FY22 and that a growth rate of 4.5 percent could be achieved. Further, the inflation rate will moderate substantially to the range of 5-7 percent in FY23. Also, the current account deficit has stopped growing. Further, the fiscal position has been consolidated by the withdrawal of exemptions and enhancement of rates of sales tax in the Finance (Supplementary) Bill.

Clearly, given the sizeable research capacity of the central bank, there is need to take the above macroeconomic projections seriously. However, there are still some questions that need be answered before the SBP outlook for the economy is accepted as realistic.

First, there is the growth expectation of 4.5 percent in FY22. The large-scale manufacturing sector appears to have lost the buoyancy it showed in the first quarter, when the growth rate was 5 percent. During October and November, the growth rate has plummeted to zero.

The likelihood of a loss of growth in the winter months remains very high due to large-scale gas loadshedding. This is impacting export industries in the industrial hub of Karachi and severely hitting industries catering to the domestic market. In addition, the construction boom appears to have slowed down and backward-linkage industries like cement have started showing decline in output. Further, cost-push factors like the impending hike in energy tariffs could also impact negatively on industrial output.

The agricultural sector also started the year well with a near 30 percent growth in cotton output. However, the Rabi crop is likely to be contained by the shortage and big increase in prices of fertilizer. In particular, the wheat output could be significantly lower. The weight of this crop is by far the highest among the major crops. Therefore, the impetus provided by the higher cotton output could be at least partially neutralized by the probable decline in the wheat output.

Overall, the SBP expectation of a 4.5 percent GDP growth rate appears to be optimistic, especially since the fiscal stimulus initially budgeted of a big increase in Federal development spending will no longer be the case. A perhaps more realistic estimate is a growth rate of 3.5 percent in FY22.

Second, the SBP has highlighted in the context of high on-going double-digit inflation in the country that on a month-to-month basis there was no change in the price index in December. However, a warning has been issued that one-off cost push pressures from energy tariff increases and removal of tax exemptions are likely to keep the year-to-year inflation elevated in the next few months. Consequently, the average rate of inflation will remain in the range of 9 percent – 11 percent throughout FY22.

The surprise is that there is no mention of the ballooning of the international crude oil prices to the highest level in many years to $90 per barrel. Already, the expectation is that along with the increase in the petroleum levy, the petroleum prices on the 1st of February could soar by up to 8 percent. The resulting increase in transport costs will have a significant impact on the overall price level.

Perhaps the most optimistic projection by the SBP is that in FY23 the inflation rate is expected to decline toward the range of 5 to 7 percent. This will be a significant relief. Now that SBP has complete autonomy and is expected to exclusively focus on inflation targeting, will it take the 5 percent to 7 percent projection as the inflation target for FY23?

Third, the SBP has highlighted that the current account deficit has stopped growing. But it is already at an exceptionally high level in December of almost $2 billion. The December 14 Monetary Policy Statement had projected the current account deficit at 4 percent of the GDP in FY22. This now means that the deficit from January to June will have to be restricted to only $4 billion. This will require a 55 percent reduction in the average monthly deficit. The likelihood of this is extremely low, especially in view of the high oil prices and the need for large imports of vaccines in the face of the rapidly spreading Omicron. Also, there are large pending liabilities with Chinese power companies which when honored could lead to a large repatriation of profits.

The outlook for the current account is of great importance, as SBP foreign exchange reserves have started falling rapidly, by over $800 million last week. The sixth Review is now likely to be completed by the IMF and $1 billion released. But there is the likelihood that the current account deficit target for the seventh review will imply a big downward adjustment. This will require a very active monetary policy.

Finally, the SBP has highlighted the success of the Government in keeping the fiscal deficit at 1.1 percent of the GDP in the first four months of FY22, at the same level as in the corresponding period of FY21. But this is not good enough because the target is to bring down the budget deficit in FY22 to 6.3 percent of the GDP from 7.1 percent of the GDP in FY21.

Preliminary estimates for the fiscal operations in the first half of FY22 have become publicly available. The deficit has apparently risen to 2.4 percent of the GDP and there is now only a marginal primary surplus. Clearly, stronger fiscal management will be required in coming months. The rise in cost of debt servicing due to the hike in the policy rate will largely neutralize the extra revenues from the changes in the sales tax.

Overall, we hope that our above-mentioned apprehensions are misplaced, and we pray that the optimism of the SBP is not out of touch with the emerging reality of the national economy.

(The writer is Professor Emeritus at BNU and former Federal Minister)

Copyright Business Recorder, 2022