It’s that time again when speculation over the State Bank of Pakistan’s (SBP’s) monetary policy stance starts to dominate business pages’ headlines. To recount, the SBP has increased the policy rate from 7% to 16% since September 2021.
This increase of 9% (and counting) is the largest jump ever in the SBP’s policy rate which puts into context the severity of the current crisis. Recent surveys indicate that over 80% of market participants expect another rate hike on 23rd January 2022.
It is interesting to note that monetary tightening is taking place at a time when most indicators of economic activity seem to be in free fall. High frequency data, including cement dispatches, petroleum sales, auto demand, consumer credit off take and large scale manufacturing (LSM) reflect a sustained slowdown in growth. Add to that supply chain disruptions, factory closures and layoffs and it is not surprising that GDP forecasts for FY23 average under 1.5%.
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Industry Unit 1HFY23 1HYFY22 % change
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Cement dispatches mn tons 20.0 24.1 -16.8%
Auto sales units 722,487 1,101,848 -34.4%
Petroleum sales mn tons 9.0 11.1 -18.6%
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Source: APCMA, PAMA, OCAC
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Inflation (24.5% in December 2022) is expected to remain elevated as long overdue structural reforms have to be implemented at the behest of international creditors.
Increase in gas/electricity tariffs to arrest circular debt build up, reduction in subsidies to consolidate fiscal bleeding and free float of PKR vs. USD are all projected to add to price pressures in the months ahead. Interestingly, almost 70% of the increase in CPI (consumer price index) is coming from food, housing and transport which are considered supply side factors and less responsive to monetary policy.
Of more concern to the SBP has been the rise in core inflation which jumped from 11.5% in June to 14.7% in December.
Normally, interest rates are used to rein in inflation emanating from excess demand which is not the case in Pakistan right now. Historically, real interest rates can dip into negative territory as long as there is stability on the external accounts and FX reserves. As of last reporting, the SBP’s USD reserves are at just USD 4.6 billion.
Debt repayments and essential imports will exhaust these in a matter of weeks unless inflows from multilateral and bilateral sources materialize immediately. Adding to these woes is increasing dollarization, hoarding of gold and the existence of four different exchange rates. In fact, the spread between interbank and grey market rates is now at a scarcely believable 15%.
The current turmoil in FX markets is driving expectations of further monetary tightening. The hope being that higher rates may incentivize domestic investors to park their savings in PKR denominated assets rather than USD/gold or at the very least slow down the pace of dollarization.
This is perhaps why the SBP chose to increase rates back in November after holding them steady since July.
In fact, if you had the pleasure of watching the last SBP presentation and did not know the decision of the committee before hand, you would have thought they were making a case for a rate cut.
The central bank must also be aware that the burden of macroeconomic stabilization once again has to be borne by monetary policy. With the majority of government revenue earmarked for debt servicing there is not much fiscal policy can do in the short term to reduce the public deficit.
The IMF’s role cannot be discounted either as it is quite likely a rate hike was one of the pre-conditions to get the program back on track. Policymakers however need to be cognizant of the death spiral higher rates may push the economy into.
Higher interest rates = higher debt servicing costs (for the largest borrower which is the government) = higher fiscal deficit = demands from creditors to increase taxes/reduce subsidies = higher inflation = higher interest rates and so on!
Pakistan does not have a demand problem. It has today and in the past been plagued by systemic supply side issues. Whether that was a dilapidated energy chain, narrow revenue base, limited human resource or low productivity. Restricting imports, capital controls or pushing the economy into a recession was never going to be more than a short-term Hail Mary. Time has almost run out.
Copyright Business Recorder, 2023
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