Since the last monetary announcement in Pakistan, where policy rate was increased by 100 bps, the global market behavior has changed due to worldwide demand compression. The central banks across the globe are now running easing monetary policies, and the commodity prices have nosedived. It is high time the SBP rethinks the hawkish stance.
The demand compression can be done to a certain point. The imports are down with monthly bill coming below $4 billion, and in the process economic activities shrunk significantly. High inflation and high unemployment can go from bad to worse, if the tightening cycle continues. In the recent T-Bill auction, higher participation in 3 months and upward rates in 6M and 12M papers reflect that market is expecting another rate hike, or the SBP is paving way for current market behavior.
The signaling is not right. The SBP has to come up front and start giving signals to move along the changing global realities. The quest of higher interest rates and further currency depreciation is to go beyond curbing current account deficit. The idea is to attract foreign portfolio investment in government papers (For details read “Betting on foreign portfolio investment”). The carry trade is already very attractive and with others lowering the rates, investment in Pakistan currency is becoming more lucrative.
The investment in domestic bonds by foreign funds has other regulatory and taxation issues which the SBP and MoF are working to resolve. It is time to focus on these issues, rather than further tightening. The foreign portfolio is hot money and it will not stick around for long. The key to have sustainable foreign and domestic investment in productive sectors is based on economic recovery and demand.
The economic confidence is eroded and is falling further. The confidence takes its own sweet time to restore. The SBP has to realize that and should start giving signals of no further tightening. The impact of recent adjustment will start coming in the next 6-18 months. Do not further push to a point where recovery becomes extremely difficult. Time is running fast.
Anyhow, overall foreign trade value is to decline and it’s going to adversely affect exports as well. There is no need to imitate the argument that exports are not picking up due to currency depreciation or further devalue the currency to jack up exports. International cotton prices are coming down – average cotton index is down by 13 percent in past 3 months- from April to July, and 20 percent in the past 12 months. Owing to trade tension, prices started falling freely in August. This will have its impact on textile exports.
The other side of the picture is that international oil prices are heading south which is lowering the import bill. This gives room for the FBR to collect taxes by not passing on the full benefit to domestic consumers. In such scenarios, inflationary expectations are to be tamed as well. The unnecessary tightening may become more harmful. Time to shift gears!
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