The PMLN government is about to leave an macroeconomic mess to handle for caretakers; and the new government might be busy in handling the deficit overdose, leave alone PTI 100-days wish list, if they come in power.
The question is how will the SBP monetary policy react to a case of twin deficit in the very last monetary policy decision of the outgoing regime. One may argue that the central bank is an independent institution and monetary policy decision making has nothing to do with who is at helm in Islamabad.
Only that the SBP staff is in minority in the monetary policy committee where six out of ten members are either external or on board of the SBP. These are appointees of ministry of finance and one may suspect that their decision making is influenced by the government.
Leaving speculations aside; here is an attempt to dissect what kind of decision the numbers suggest. The fiscal deficit reached 4.3 percent of GDP in 9MFY18, and would be north of 6 percent of GDP by FY18 end - worst in PML-N’s five years. The current account deficit stands at an annualized 5.3 percent - worst in five years as well.
Foreign funding was absent in the third quarter; the reliance of deficit financing fell on banking sources. The domestic banking fiscal borrowing stood at Rs481 billion - highest quarterly borrowing in the government’s 5-year tenure. And this number may only grow further in 4QFY18.
This is inflationary in nature; core inflation reached 7 percent in April which is a 42-month high. All these record breaking indicators suggest that 10 percent currency adjustment (5% in Dec17 and 5% in Mar18) and 25 bps increase in policy rate may not suffice to unwind the deficits.
The pressing need is to do more. The reserves are falling fast and the debt is piling at an even higher pace. The metaphoric term, no debt; no life is becoming true in the short to medium term. In order to break the jinx of debt fueled growth, some tough policy measure are need of the hour.
The SBP foreign reserves are covering merely 8 weeks of goods and services imports. This is a critical level; as below this it is extremely difficult to sustain for a few months. The imports need to be curbed and for that demand needs to be managed.
The currency depreciation of 10 percent has brought REER close to its equilibrium. The external balance snapshot reveals that REER came down from 124.2 in Nov17 to 111.7 in Mar18, and it may further slide to 105-7 in Apr 18. With REER fast approaching equilibrium, in order to correct the imbalances, a hike in policy rate is imperative for managing demand.
Core inflation is often the prime consideration in monetary policy decision. A sudden hike in April to 7 percent is attributed to mysterious hike in house rent index, easy monetary policy and second round effect of commodity prices.
The rise in commodity prices. especially oil is worrisome. The imports (PBS) are marching to towards $60 billion; as oil prices jumped by 54 percent between Jun17 and Apr18. This will have some toll on inflation and import bill.
The days are tough ahead; the principal foreign debt repayment is $3.2 billion in Apr-Jun, with commissioning on new capacities of imported gas and coal plants, energy imports may further jack up in summers.
In short, the deficit may go deeper in months to come; seeing this the monetary policy needs to jack up rates by at least 50bps tomorrow.
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