Too early to declare victory

Addressing business and industrial leaders as well as bankers at an interactive session organised by the Federation of Pakistan Chambers of Commerce and Industry (FPCCI), Governor SBP Reza Baqir asserted that the economy is moving in the right direction, State Bank foresees a growth rate of 3.5 percent for FY20 and is prepared to meet any external shocks, either in the form of a military challenge due to the situation in Kashmir, or from the rising oil prices in the international market. However, he was quick to add that "we have to sustain our policies in order to gain the confidence of local and foreign investors." SBP has focused on three major areas viz. exchange rate, foreign currency reserves and interest rates to pull the country's economy out of the woods. Responding to business leaders' criticism that the policies of the SBP have slowed down the economy, discouraged investment and increased unemployment, the Governor explained that the SBP had to adjust the exchange rate which is artificially kept at a lower level. The readjustment of exchange rate has brought about a semblance of stability in foreign exchange reserves but it is "too early to declare victory." The most encouraging development is the narrowing of C/A deficit from dollar 2 billion a month to dollar 579 million by July this year, showing a contraction of 73 percent. Referring to the complaints of high interest rates, Governor said that all over the world, central banks use this instrument to fight inflation. Besides, in order to measure the real interest rate, we have to compare the nominal interest rate with the inflation rate. For instance, if "we have 13.25 percent policy rate and estimated inflation rate of 13 percent, this would mean that the real and true interest rate is 0.2 percent only." This is where other economists in the country including Dr Hafiz Pasha and Ashfaq Hasan Khan differ with Reza Baqir as they argue that the ground realities in Pakistan are different from those in developed countries and it is 'core inflation' and not 'nominal inflation' that is relevant for deciding the discount rate because consumer borrowing to finance personal consumption is virtually negligible. As far as fiscal deficit is concerned, the issue is related to the government and the only way out is to increase revenue collection.
However, some of the observations of the Governor at the interactive session are debatable at this stage. For instance, his estimate that the growth rate could be 3.5 percent during FY19-20 seems to be over-optimistic. Most of the other agencies estimate the growth rate to be around 2.5 percent. The SBP may have been encouraged by recent rains to estimate a higher growth rate but such an estimate is premature and appears to be on a higher side. Also, the Governor seems to be highly pleased with the latest data on C/A balance. It is true that the C/A deficit has narrowed from an average of nearly dollar 2 billion per month during FY19 to dollar 579 million in July, 2019 but a single month's data is not sufficient to indicate or establish a trend and we should wait for a few months more to rejoice over this healthy development. Besides, Reza Baqir has stated that the SBP is prepared to meet any eventuality, either in the form of military challenge or from rising oil prices in the international market. We are afraid that the present level of foreign exchange reserves held by the SBP is not enough to make such a bold statement. The Governor is, nonetheless, right to say that it was "too early to declare victory" and, in our view, he should stick to this line of reasoning, at least for the time being.