Inflation expectations are becoming entrenched in Pakistan. There is a case of seven straight months of twenty percent plus (thirteen months of double-digit) inflation and counting. That is unusual in Pakistan. Last time, such spell was in 2008-12 when in fifty two out of fifty-four months inflation was in double digits with seven months of 20 percent or more. At that time the inflation expectations did build – but this time it seems the impact is higher.
The inflation spree this time originated from cost-push and supply-side factors and now increasingly is being driven by inflation expectations. Historically, business surveys conducted by SBP showed that inflation expectations had remained low. But now it’s changing. This is reflected in businesses' price setting and consumers' expectations about it.
The need is for monetary and fiscal policymakers to take this seriously and act accordingly. With increased political uncertainty and fiscal authorities focusing on saving political capital, consumers and businesses are thinking that the government is not serious about controlling inflation. That is further entrenching the expectations.
Informal talks with capital market players suggest that they now question the independence and creditability of the SBP and monetary policy committee. Analysts’ forecast is usually based on what they expect SBP to do. Not on their view on what SBP should do. That is why the overwhelming majority was expecting no change in the policy rate last time. And now with the 100 bps increase last time, everyone is talking about a further increase. In fact, there have been rumors of an emergency meeting of MPS in the community for the last few days.
There is no truth in these rumors. Firstly, emergency meetings cannot be planned. Secondly, the rumor is due to the delay of SBP issuing the monetary policy calendar for the next six months. It is in the process of approval. SBP should expedite it to put an end to the market anxiety. Thirdly, the finance ministry is delaying the resumption of the IMF programme by not taking tough decisions, and this implies no further increase in rates on an emergency basis.
The question is what SBP may do in the next policy and how would it ensure undoing the building inflation expectations. Well, SBP has the tool of tightening, and it should and would use it depending upon the data and fiscal management. The inflation expectations are growing with the fear of default. People are preponing consumption. Some are thinking that PKR savings will lose value. Then the wages are growing to counter inflation and that is building the expectations of a second round effect of inflation – perhaps it is already happening.
In 2008-09 period of twenty percent plus inflation, SBP was quick to act, and the discount rate (there was no policy rate) was increased to 15 percent. Then it was in the IMF programme; yet it took four years before inflation tamed down. Now the policy rate is at 16 percent- and discount rate at 17 percent.
The question of any further tightening must be based on expectations. Some feel that this time round expectations have a bigger role to play due to domestic political uncertainty, fear of default and global recession. The base effect will keep inflation in 20s till March 2023. It’s important to see month on month number and if the rate remains high, SBP must act through policy measure and effective communication on expectations.
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