Monetary policy blues

EDITORIAL: The Monetary Policy Committee (MPC) in its meeting of 12 December 2023 kept the discount rate unchanged – a decision in spite of acknowledging a massive rise in gas prices – (a 1108.59 percent higher in the first quarter of the current year against the same period the year before as calculated by the Pakistan Bureau of Statistics (PBS), an administrative measure pledged in the ongoing Stand-By Arrangement (SBA) with the International Monetary Fund (IMF) offset by the decrease in the international prices of oil and higher farm output (a usual outcome after a flood year).

It is noteworthy that the policy rate was last raised on 26 July by 100 basis points to 22 percent, and was kept unchanged in the next three MPC meetings - 14 September, 30 October and 12 December; however, inflation did not decline as per the expectations cited in the monetary policy statements.

Headline inflation registered 28.3 percent in July this year, which may have been the reason for the rate hike, however; it registered 26.8 percent in October this year and rose to 29.2 percent in November – a steeper rise with the policy rate left unchanged.

Core inflation has not been gradually coming down as claimed in the MPS (monetary policy statement) – it was estimated at 18.6 percent for November, up from 18.5 percent in October as per the PBS.

In this context it is also relevant to note that reports by independent economists and surveys conducted weekly by Business Recorder indicate that PBS inflation calculations err on the side of optimism.

Three other discrepancies in the MPS are evident between data released by the Pakistan Bureau of Statistics and SBP: (i) the claim that workers’ remittances improved in October, by 217 million dollars compared to October 2022, was not only as stated “incentivised” by SBP and the government initiatives (the caretaker finance minister announced an 80 billion rupee package for the purpose on 15 September with 20 billion rupee disbursed the next day); however, not acknowledged is the fact that remittances were suppressed in October 2022 because of the then Finance Minister Ishaq Dar’s policy to control the interbank rupee-dollar parity without the necessary foreign exchange reserves to intervene in the market, which, in turn, led to the resurgence of the illegal hundi/hawala system. And in November 2023 remittances actually declined to 2050.5 million dollars against 2173 million dollars in November 2022 that may well indicate that the rise in remittances in October this year was perhaps a one-off; (ii) the claim that successful completion of the SBA’s first review will “unlock financial inflows and improve the SBP’s foreign exchange reserves” needs immediate consideration for the obvious reason that since the staff-level agreement on the SBA was reached on 29 June 2023 the usual upgrade by the international rating agencies has not taken place, which places the budgeted reliance of around 6 billion dollars (envisaged from borrowing through issuance of sukuk/Eurobonds and commercial borrowing from abroad) at risk.

The caretaker finance minister publicly stated that this shortfall would be made up from other sources, bilateral/multilateral, as well as foreign direct investment inflows, however, till date these inflows have not yet been forthcoming; and (iii) tax and non-tax revenue has increased by 29.6 percent, a remarkable achievement; however, the tax-to-GDP ratio continues to be under 10 percent, an appallingly low rate region-wise that would require much more concerted efforts on the part of the Federal Board of Revenue to broaden the tax base.

While serious efforts are under way, yet so far there has been little success on the ground. And the petroleum levy, the highest contributor to budgeted non-tax revenue (other than SBP profits) and referred in the MPC as showing substantial growth, is imposed in the sales tax mode, which is an indirect tax whose incidence on the poor is greater than on the rich.

Presumably, the reason for levy as non-tax revenue is to visually differentiate it from revenue that is shared with the provinces under the National Finance Commission award. At present, the government has maximised the per litre levy to 60 rupees which was possible in terms of public acceptability due to the decline in the international prices of oil. In the event of a rise in oil prices in the international market, this low-hanging fruit may become a challenge.

The MPC also notes that recent consumer and business confidence surveys show an improvement in sentiment (a reliance on SBP’s survey on sentiment that appears to be rather contentious, given the fact that imports of raw materials continue to be constrained with the objective of dealing with current account issues while exporters are publicly lamenting their inability to compete internationally due to their high costs particularly on energy); and later notes that broad money growth decelerated to 13.7 percent year-on-year as of 24 November 2023 from 14.2 percent end-June due to net retirements in private sector credit and more than seasonal decline in commodity operations financing.

In this context it is appropriate to quote the IMF’s cautionary note in its press release dated 15 November 2023, “continued vigilance is warranted to safeguard the soundness of the banking system. Priorities include addressing undercapitalised financial institutions, ensuring foreign exchange exposures within regulatory limits, and aligning bank resolution and crisis management frameworks with best practices.”

Maintaining the discount rate at 22 percent may be sourced to the IMF’s concurrence during discussions on the first review (3 November to 15 November) no doubt due to strict adherence to implementing the agreed SBA conditions rather than to the prevailing economic fundamentals.

One can only hope that the government begins implementing structural reforms now, while till-date it was mainly focused on implementing administrative measures, so that macroeconomic fundamentals begin to improve.

Copyright Business Recorder, 2023