A prudent approach

As anticipated by this newspaper, the Monetary Policy Committee (MPC) of the State Bank in its meeting held on 22nd November, 2019 again opted to keep the policy rate unchanged at 13.25 percent per annum for the next two months. It has justified its decision mainly on the ground that recent inflation outturns have been on the higher side but the causes behind these outturns have primarily been increases in food prices which are expected to be temporary. "Also market sentiment has begun to gradually improve on the back of sustained improvements in the current account and continued fiscal prudence." In the real sector; economic activity is strengthening in export- oriented and import competing sectors while inward oriented sectors continued to experience a slowdown in activity. In sum, the central bank has kept its projection for GDP growth rate for FY20 unchanged at around 3.5 percent. The external sector has continued to show a steady improvement. During July-October, 2019, current account (C/A) deficit contracted by as much as 73.5 percent to dollar 1.5 billion. This improvement reflected a substantial reduction in imports, modest growth in exports and steady workers' remittances. The capital and financial accounts also improved due to higher FDI and continued portfolio inflows. The rupee has appreciated by 5.6 percent since its low in June, 2019 on account of these favourable factors while SBP has begun to rebuild gross reserves and reduce foreign liabilities.

Fiscal consolidation has also gained traction on account of taxation reforms and strict control on non-development expenditures. Tax collection by the FBR grew by 16.2 percent in July-October, 2019 compared to only 6.4 percent in the same period of last year. Federal releases for PSDP more than doubled to Rs 257 billion in the first four months of the current fiscal as compared to Rs 105.5 billion in the corresponding period a year earlier. Private sector credit fell by Rs 4.1 billion during July-October, 2019 as compared to expansion of Rs 223.1 billion in the same period a year earlier on account of slowing economic activity. Inflation rose by 11 percent (y/y) and 1.8 percent (m/m) in October, 2019. Nevertheless, MPC was of the view that inflationary pressures are expected to recede in the second half of the current fiscal year due to compression in domestic demand and appreciation of the rupee. For the year as a whole, average CPI inflation is projected to be in the range of 11-12 percent and maintaining the current monetary stance is appropriate, given the overall scenario.

In our view, the MPC must have been hard put this time to strike a delicate balance between various competing considerations and reach an appropriate monetary policy decision to ensure financial stability in the long-run without sacrificing growth prospects of the economy. This was particularly so because the arguments to cut the policy rate by a slight margin or keep it unchanged were almost equally balanced this time. A sharp improvement in C/A deficit during July-October, 2019, particularly a surplus in the C/A balance during October, 2019, appreciation in the rupee rate in the forex market, increase in gross reserves of the country by dollar 1.16 billion, reduction in liabilities by dollar 1.95 billion through end-October, 2019, strengthening of fiscal consolidation through increase in tax revenues, control on non-development expenditures, increase in FDI and revival of business confidence had raised the expectation that the MPC would opt for easing of monetary policy this time. Expected softening of price pressures in the second half of FY20 and a reduction in private sector credit against a sharp expansion in the same period of previous year were also factors pointing in the same direction. However, the State Bank does not seem to be in a hurry and wants to be sure about the continuity of the present trends and stability in prices before making the next move. The MPC seems to be particularly perturbed over the current high inflation rate of about 12 percent which has not fallen despite tightening of both fiscal and monetary policies. The latest data on prices indicated a higher rate of inflation than earlier expected by the MPC. Although higher than expected inflation was basically due to upward adjustments in administered prices and rise in the prices of food items primarily due to supply disruptions, the SBP cannot afford to lower its guard if the price pressures continue to persist in the economy, making the lives of ordinary people more miserable with the passage of time. The MPC may have a better chance to reduce the policy rate in the next meeting if the data on prices shows a declining trend and other macro-economic variables continue to be favourable. It also needs to be emphasised that under the current EFF programme with the IMF, Pakistan is required to follow a relatively strict monetary policy to keep the monetary aggregates in check. A premature easing of monetary stance could, therefore, be called into question by the IMF.

However, there is no doubt that maintaining the status quo on monetary stance would be severely criticised by various stakeholders, particularly the business community. Most of the time, they argue that higher a policy rate and consequent increase in the lending rates lead to higher cost of production which is responsible for higher inflation. A large part of the vernacular press also speaks the same language with the result that such a perception has continued to strengthen over time and the SBP is usually blamed for raising inflationary pressure in the economy. Such an impression, in our view, needs to be dispelled by the SBP by organising seminars and workshops, especially for the media to demonstrate that such criticism is totally unjustified. A hike in the policy rate in fact is meant to reduce inflationary pressures in the economy through compression in demand and vice versa. A better understanding of the monetary policy by the critics would make the job of the central bank less contentious and address incorrect perceptions.