The monetary policy is due tomorrow - market expects no change to 75 bps increase in policy rate, currently at 10.25 percent. After seeing the minutes of last MPS, a few have informally lowered the expectations of increase. The talks with the IMF are probably on maintaining around 200 bps real interest rates, and based on revised (lower) inflation forecast, the chances of no change to 25 bps increase are high.
Apart from numbers, there is a political perspective, and based on recent monetary policy communications. politics is playing a decisive role. The IMF's tone is changing for Pakistan - a few months back, the US officials were pressurising on not extending the IMF loan to Pakistan, if used for repaying Chinese loans. Now the noise is that the US is supporting Pakistan in IMF negotiations, Pakistan being key partner in US-Afghan negotiations.
The tone of last monetary policy statement was hawkish, as at that time, there was a tussle going on between SBP and MOF; while in the minutes of the same meeting, the tone is dovish. The shift in MPS communication is a recent norm (read "MPS-another U-turn").
Back to numbers. The yardstick is assumed to keep real interest rates at 200 bps. The question is on what number the parity will be kept - is it based on Feb19 CPI or core inflation, anchored on period average or 12-month average, or on March expected inflation or full year expected inflation. Seeing, from any lens, 200 bps real interest rates is the case now.
The CPI stood at 8.3 percent in February and is expected at 8.8-9.1 percent in March, which is expected to roll back based on ending of the high base effect in April. The SBP has lowered its end year inflation from 7.4 percent to 6.8 percent. The full year inflation forecast is unchanged at 6.5-7.5 percent with next year inflation expected at 7 percent. The core inflation probably peaked in February at 8.8 percent and may come down to 8.3-8.5 percent in March and remain around 7.5-8 percent going forward.
Thus, based on inflation, there is no solid reason to further hike the interest rates. The second factor is to curtail aggregate demand to lower the current account deficit. Feb19 was a much needed breather with monthly deficit at $356 million - expect the average monthly CAD at $500 million for the rest of the calendar year. There is no apparent rationale for hawks to dominate based on external demand.
The next factor is exchange rate. Inflation in Pakistan has so far remained largely insulated to exchange rate depreciation as food prices in Pakistan, prior to currency adjustment in Dec17, were at steep premium to international prices (read "Impact of currency depreciation"). Now, that benefit is utilised, and any further currency adjustment can result in higher food prices. This intuitively implies that currency is close to parity - REER calculated by the SBP at 103.17 is showing that the currency is almost at its equilibrium. There is no urgent need to depreciate and in turn further interest rate hike is not warranted.
The other way to look at it is to see the interest rates and inflation differential with trading partners and regional competitors, especially the US and India. The Fed has changed the outlook for less increase; inflation in India is at 2 percent, and there is deflation in Malaysia. The global outlook on inflation is falling, and based on interest rate differential, tightening at home is not called for.
The real issue is fiscal and low economic growth. It is a no brainer that higher interest rates are not good for growth outlook while on fiscal side the biggest problem in the short term is debt servicing - higher rates imply higher domestic debt servicing cost. The PSDP is already too low and not much can be done through interest rate hike to cut down other expenditure or jack up revenues.
The bottomline is that the rational choice is to keep interest rates unchanged, but T-bills yields are suggesting 50 bps increase, so the SBP may opt for a showcase jump of 25 bps.
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