Treading with care

Analysts were almost equally divided over whether the monetary policy is eased further. However, the Monetary Policy Committee (MPC) of the SBP decided to keep the policy rate unchanged, mainly on the ground that though performance of the economy during FY16 was wholesome, it was not so sure about the developments during the current fiscal. Commending the economic achievements during 2015-16, MPS says that average inflation declined to 47-year low of 2.9 percent and GDP growth touched an eight-year high of 4.7 percent during FY16. Foreign exchange reserves at the end of June, 2016 stood at $18.1 billion, enough to cover four months of imports. Revenue collection exceeded expectations and private sector credit posted a considerable surge. Looking at the impact of these improvements, SBP had cut its policy rate by a cumulative 75 basis points (bps) in FY16; over and above a cut of 300 bps in FY15. Both external and domestic factors contributed towards improvement of country's economy. On the external front, foreign exchange market remained broadly stable due to lower oil prices, healthy workers' remittances and adequate official capital inflows. On the domestic front, "an increase in FBR revenues helped in increasing development spending, while at the same time maintaining fiscal deficit close to the target level."

Going forward in FY17, factors affecting the outlook for external sector were broadly similar to that of FY16. A positive growth in workers' remittances is likely to keep the C/A deficit within manageable levels. Substantial bilateral and multilateral project loans will help maintain an overall surplus in the balance of payments. Foreign portfolio investments on the back of reclassification of Pakistan stock market upgrade to emerging market from a frontier market by MSCI were also likely to increase the inflows. However, trade deficit may widen due to an increase in oil prices, a slowdown in China, deceleration in workers' remittances due to a slowdown in the Gulf region and uncertainties about the recovery in the EU in the post-Brexit period. GDP growth was set to increase further due to rising investment under PSDP and the CPEC, improved energy availability, prudent monetary policy, healthy private sector credit uptake and improving law and order situation. A successful end to the IMF programme will also bring much-needed confidence boost to Pakistan's economy. However, increased economic activity may impact the rate of inflation. SBP expects the average CPI inflation in the range of 4.5-5.5 percent during FY17. An upward adjustment in gas tariff, fiscal slippages, supply disruptions, uncertain global oil prices and possible dampening impact of Brexit on global commodity prices, nevertheless, pose risks to this inflation forecast.

Though the business community, in general, and the government would have welcomed another cut in the policy rate for obvious reasons, yet sticking to the present monetary stance, in our view, was a better option at this stage. The case for such an option was well advised and nearly solid. While those advocating for a reduction in policy rate based their arguments largely on the past achievements, particularly on a sharp deceleration in the inflation rate and considerable increase in foreign exchange reserves of the country, MPC was more concerned about the future trend in these aggregates. Though the fall in CPI inflation to only 2.8 percent during FY16 would appear to be a major achievement in the context of Pakistan, such a trend is not likely to persist. The SBP has projected the CPI inflation in the range of 4.5-5.5 percent for FY17 which is nearly double the rate witnessed in 2015-16. There are a number of factors responsible for this forecast. An upward adjustment in gas tariff, fiscal slippages, increase in oil prices, supply disruptions, etc., could pose a risk to price stability in the coming months. A downward adjustment in the policy rate could have exacerbated the effect of these factors through increasing demand pressures and pushed up the CPI inflation further. It needs to be emphasised that the major task of a central bank is to ensure price stability which does not impoverish the lives of ordinary people and is also conducive to economic growth. Such an outcome is only possible by following a prudent monetary policy approach. The MPS, citing a number of favourable developments, has also stated that GDP growth would get an impetus from these positive factors but continued a declining trend in commodity prices and any setback to security situation could hamper the possibility of achieving the GDP growth target of 5.7 percent in FY17. In the MPS, improving law and order situation has been indicated as a reason for a better performance of the economy without recognising that recent killings in Karachi and kidnappings in Punjab have already weakened the perception of a relatively safe and secure Pakistan. As a result, investors would continue to be wary about investment prospects in the country. Also, the area sown under cotton crop has declined by almost 20 percent and this will dampen the growth prospects of economy, leading to lower availabilities and higher inflation which would need to be countered by an appropriate monetary stance.

The risks to the external sector are even graver than mentioned in the MPS. There is every reason to believe that exports would decline and trade deficit could widen further in the coming months. State Bank's contention that a successful conclusion of the present IMF programme would boost the confidence level in Pakistan's economy is highly debatable. The past experience suggests that when the country bids farewell to the IMF, the reform process slows down or is discontinued, undermining the confidence level of investors in the economy which forces the country again to approach the IMF for assistance. As the inflows from the IMF and through the CSF may be stopped after sometime, foreign exchange reserves of the country may come under pressure. The SBP expects a positive growth in workers' remittances but such a healthy development may not materialise due to lower oil prices in the international market obliging the oil exporting countries to constrain their developing expenditures and reduce the number of expatriates working in their countries. The State Bank's argument that the reclassification of Pakistan stock market in the Emerging Markets Index by MSCI would increase portfolio investment is not at all convincing. This is such a minor development that foreign investors would hardly take notice of such an event. Moreover, portfolio investment is speculative in nature and largely unimportant for the growth of a country. A profound comment on rupee-dollar parity, external debt and debt servicing and utilisation of forex savings was badly missed. Overall, it was better for the MPC to adopt a cautious attitude before making another downward adjustment in the policy rate. We are happy that the SBP has done the same and is treading with care to avoid the re-emergence of inflationary pressures and setback to external sector outlook.