The outgoing monetary policy committee salvaged its position by a token increase of 25 bps in the policy decision yesterday. The market remained indifferent to the rate hike as banking treasurers consider the move superficial as it is perhaps just to appease IMF and face saving of not taking another ‘U-turn’ inside ten months.
The crux of the Governor’s speech is that the fiscal side is yet to show consolidation despite reduction in development spending. This one sentence shows that SBP is working independently with little or no influence of the MoF. It was the same SBP internal team and same monetary policy committee that did not even dare give a passing reference of fiscal slippages, back in Dar days.
The fiscal deficit started growing in FY17; but in numerous policy decisions that year and even in part of FY18, there was no mention of the fact that growing fiscal deficit was a cause of concern. Extravagant government spending and financing from the banking system, using reverse OMO operations, was overheating the economy.
That was the time when there was supposed to be an effective use of policy rate to correct the macroeconomic imbalances i.e. to stop the translation of growing fiscal deficit into higher current account deficit. The monetary policy was numb at that time on the very issue which was repeatedly highlighted in this space.
The delay in policy action resulted in ballooning of current account deficit, and SBP was too late to react. Now, it is nothing but face saving with little economic impact. Yes, the fiscal deficit is yet to show consolidation; but there is a limit to monetary tightening impact on lowering fiscal deficit, and in turn current account deficit.
The government is already trying to control fiscal deficit by having an austerity spree. At this point, the biggest concern to fiscal expenditure is debt servicing (mainly domestic debt servicing), and any increase in interest rates would have adverse impact on debt servicing - a circular problem.
The current account deficit is on a decline and the SBP Governor implied that 2HFY19 CAD would be around $5-6billion versus $8 billion in 1HFY9. The SBP is keeping its inflation forecast unchanged at 6.5-7.5 percent and expects GDP growth to be around 4 percent. There is a clear sign of slowdown in aggregate demand and going forward the transmission of previous rates hike and currency depreciation would have adverse impact on the aggregate demand.
It is hard to comprehend the rationale of 25 bps increase in interest rates. The secondary market yields have came down by 40-45 bps in the past few days and yesterday, in the last hour, after the Governor announcement, yields remained largely flat – the market seems to have discounted the increase in discount rate.
The MPC is about to change. Here is hoping the new committee takes decisions based on fundamentals and not on sentiments or in fear of the MoF (in Dar days) or the IMF (today).
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