EDITORIAL: From a macro-perspective there was good news, however slight it maybe for the growing number of sceptics of fiscal and monetary policy decisions, on two fronts this Monday past: State Bank of Pakistan (SBP) lowered the discount rate by 100 basis points to 19.5 percent and Fitch upgraded Pakistan’s rating from CCC (extremely speculative) to CCC+ (substantial risks).
There is an obvious disconnect between the decision to cut the rate by 100 basis points as headline inflation rose to 12.6 percent in June 2024 year-on-year compared to 11.8 percent in May 2024 with the Monetary Policy Statement (MPS) noting “risks to the inflation outlook from fiscal slippages and ad hoc decisions related to energy price adjustments” and the projection that “relatively lower interest rates and higher budgeted development spending” would fuel growth to between 2.5 and 3.5 percent compared to 2.45 percent last year – a projection that is a tad too optimistic as the reduction in rate may not be adequate to fuel productive activity especially as other costs, utilities and transport, continue to rise while development spending is the first casualty every year to contain the deficit.
The MPS states that “core inflation has steadied at around 14 percent over the past two months” – a rate at odds with that calculated by Pakistan Bureau of Statistics - 12.3 percent for May and 12.2 percent for June. It is noteworthy that the difference between the discount rate and the 14 percent core inflation is 5.5 percent and over 7 percent with the CPI, wider than the norm.
The Committee noted four key developments since its last meeting. Firstly; the current account deficit narrowed sharply and foreign exchange reserves strengthened by 4.4 billion dollars end-June 2024 to above 9 billion dollars.
However, the total reserves still comprise borrowing mainly besides through open market operations and secondly; though during the Monday press conference SBP officials claimed that the Bank did not take any measures to administratively contain imports yet data indicates a reduction in imports of fuel from around 20 billion dollars July-June 2023 to 16 billion dollars in 2024 – a decline reflective of the government’s decision to curtail fuel imports in an effort to improve the balance of payment position.
There is considerable angst against this policy as it has had repercussions on a wide-range of productive activities, which was acknowledged in the MPS as another key development: “the sentiment survey conducted in July showed worsening inflation expectations and confidence of both consumers and businesses.”
Thirdly; the staff-level agreement with the Fund for 7 billion dollars was reached on 12 July though the prior condition of securing 12 billion dollar rollovers from the three friendly countries for the duration of the programme is still in process.
And finally and bafflingly; as Pakistan economy remains relatively isolated, the MPS noted the “ease in inflationary pressures and labour market conditions, central banks in advanced economies have also started to cut their policy rates.” The MPS expressed legitimate concern over increasing reliance on banks for deficit financing which “has been squeezing borrowing space for the private sector” though it did not flag this as a major contributor to inflation and emphasised achieving “fiscal consolidation and timely realisation of planned external inflows to support overall macroeconomic stability.”
The reduction in reliance on deficit financing is a function of access to foreign markets at a reasonable rate, which, in turn, will depend on the Pakistan’s rating by the three international rating agencies: Fitch, Moody’s and Standard and Poor’s wherein lies relevance of the improvement in our rating by Fitch.
Two observations related to the upgrade are in order. First; prior to the upgrade there was synchronicity between the ratings of Fitch at CCC- and Moody’s at Caa3 - the lowest spectrum within the speculative grade - very high credit risk, just above the near default cut-off.
By raising it to CCC+ Fitch retained Pakistan in the same speculative grade or very high credit risk though the country was given a jump to CCC+ instead of the next level up of CCC. It stands to reason that Moody’s too would upgrade Pakistan similarly from Caa3, (February 2023), to Caa1 instead of Caa2, the next level up.
Standard and Poor’s rated Pakistan at CCC+ since 22 December 2022 and it is unlikely to change that rating. It is yet unclear whether this upgrade will enable the country to borrow at a reasonable rate externally.
The Finance Minister has repeatedly stated there was no Plan B to securing the Fund package and with the staff-level agreement reached, the upgrade in the country’s rating was expected as the process to meet all prior conditions is under way.
The reduction in the policy rate was almost certainly approved by the Fund no doubt on the grounds that it was necessary to send a positive signal to the market though sceptics may dismiss it as too little.
However, what remains a source of serious concern is the fact that these two positive news items are unlikely to improve the sentiment of the majority of people of this country that fiscal and monetary economic policies are on the right path which, if protests continue and gather momentum, may compromise the government’s capacity to take any informed decisions. Pakistan is almost certainly in the eye of the storm and hence complacency cannot be countenanced in any manner whatsoever.
Copyright Business Recorder, 2024
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