The stance of monetary policy

The Monetary Policy Statement for March 2018 has been announced recently by the Monetary Policy Committee (MPC) of the SBP. This statement comes as a big surprise with no change in the policy rate. The optimism of SBP is epitomized by its assessment that the economy is capable of 'sustaining the growth momentum without posing a risk to stability.' Apparently, the steps taken to date, including the recent downward movement in the rupee of 5%, are adequate for achieving this goal.
The optimism on economic growth is based on the improved performance of the large-scale manufacturing sector of over 6% up to January 2018. However, there is recognition of the shortfall in the cotton crop. It is surprising that there is no mention of the severe water shortage which could impact negatively on Rabi crops, especially wheat. Fortunately, SBP has abstained from making an explicit forecast of the GDP growth rate in 2017-18, unlike earlier assessments when it stated with confidence that it will be 6%.
Similarly, the optimism on the continuation of a low rate of inflation (in the CPI) is based especially on 'subdued food prices.' Consequently, the SBP/MPC expects that the rate of inflation will be substantially below 6% in 2017-18, at about 4% on average. It goes ahead to project the rate of inflation in 2018-19 at close to 6%. The jump of two percentage points needs to be explained. Is it likely to be the anticipated further jump in international commodity prices, especially oil, or due to further depreciation in the value of the rupee next year?
The surprise is that the MPC did not wait a few days for the release of the estimate of the rise in the CPI in March 2018. Perhaps it did not expect the big increases in POL prices and the depreciation of the rupee to have had any additional impact on the price level.
The positive assessment of the state of the economy by SBP is also demonstrated by its expectation that credit to the private sector will continue growing. Actually, it has shown only modest growth of 3% up to mid-March 2018. This is despite the fact that Government debt with commercial banks has come down and there has been, therefore, no 'crowding out.' SBP has preferred not to highlight the extraordinarily high level of borrowing from it by the Government of Rs 1040 billion by mid-March 2018. What impact is this likely to have on inflation with a lag, especially if the decline in net foreign assets is controlled by a new found stability in foreign exchange reserves in coming months as anticipated by the SBP?
Turning to the balance of payments, SBP does highlight that the current account deficit has increased by 50% up to February 2018. It does, however, point out the positive development in the form of the return to growth of exports by 12% but does not mention the even higher rate of increase in imports of 18%. Needless to say, it makes no projection of the likely annual current account deficit in 2017-18.
The overall posture of monetary policy as implied by the MPC appears to be passive, with continued focus on being expansionary in nature. SBP has skilfully placed the task of aggregate demand management on fiscal policy. Two statements highlight the 'passing of the buck' to the Ministry of Finance.
First, the MPS says that 'the extent of Government borrowing would determine the trend of M2 growth in coming months' along with the expansion in private sector credit with, more or less, unchanged interest rates. Second, it clearly says that 'Government plans to timely mobilize external inflows, both official and commercial, will play a pivotal role in maintaining adequate level of foreign exchange reserves and anchoring sentiments in FX markets.' Does this mean that SBP proposes no intervention in the foreseeable future in the markets of foreign exchange? Meanwhile, the MOF is well on the way to a record fiscal deficit of over Rs 2200 billion this year, unless expenditure is strongly controlled in the last quarter of 2017-18.
The passive approach adopted by the MPC is inexplicable. This is justified on the grounds that some time may be allowed for the impact of recent policy developments to unfold and meanwhile the policy rate may be maintained at 6%.
The unfortunate fact is that Pakistan is in an incipient financial downturn. Despite the flotation of $2.5 billion of Euro/Sukuk bonds, foreign exchange reserves with the SBP have declined by $4.3 billion already this year. If the external liabilities due to 'swaps' are taken into account, then the reserves are down to $4.7 billion, not even enough to provide one month cover of imports.
Therefore, there is need for both monetary and fiscal policy to work jointly and reinforce each other to stabilize the economy on an urgent basis. Most analysts had expected that there would be a 25 to 50 basis points jump in the policy rate.
Surely, there is recognition of the fact that, ex post, the trade deficit in goods and non-factor services is equal to the investment-domestic savings gap. If the former is lower than this implies a smaller current account deficit and thereby less pressure on the balance of payments and reserves. Monetary policy clearly has a major role to play in influencing the size of the investment-savings gap especially with the instrument of interest rates. The latter are influenced by the policy rate set by the SBP.
The outcome in 2017-18 clearly highlights this point. The trade deficit in goods and non-factor services went up sharply from 6.9% of the GDP in 2015-16 to 9.5% of the GDP in 2016-17. Consequently, the current account deficit has increased sharply by 2.3% of the GDP. The jump in the investment-savings gap was due almost entirely to a big fall in the domestic savings rate from 8.7% to 6.3% of the GDP.
Interest rates do impact on savings. The low nominal rate of return in 2016-17 has affected, first, deposits with commercial banks, which have increased by only 1% during the current year. Also, the inflow into National Savings Schemes has plummeted by over 30% this year due to rates of return much lower than those prevailing four to five years ago.
The bottom line is that the MPC/SBP ought to have been more proactive. A signal may have been sent out that the nature of monetary policy will henceforth be more contractionary in character so as to also contribute to early and sustained stabilization of the economy.
(The writer is Professor Emeritus at BNU and former Federal Minister)