Monetary Policy Committee (MPC) of the State Bank, in its meeting held on 28th January, 2020, opted once again to leave the policy rate unchanged at 13.25 percent per annum for the next two months. Justifying the decision, the MPC was of the view that recent inflation outturns have been on the high side and "there remain near term risks to inflation primarily from food price shocks and potential increases in utility prices." On the other hand, ongoing fiscal consolidation and recent appreciation of the exchange rate of rupee are expected to moderate the price pressures. However, SBP's projection for average inflation remains broadly unchanged at 11-12 percent for FY20. The current monetary policy stance was also viewed as appropriate "to bring inflation down to the medium-term target range of 5-7 percent over the next six to eight quarters."
In the real sector, SBP's projections for GDP growth for FY20 are likely to be revised downward on account of adverse supply-side shocks to cotton production as well as the contraction in the LSM sector. Nevertheless, available indicators of activity show that the slowdown in most economic sectors appears to have bottomed out, and a gradual recovery is expected in the coming months. Fiscal consolidation is on track during the year to date. While non-interest current expenditures were strictly controlled; federal releases for PSDP stood at Rs 300 billion in H1-FY20 as compared to Rs 187 billion in the same period of last year. Continuation of fiscal prudence would remain critical for effective anchoring of market sentiment and improving inflation outlook. Current account (C/A) deficit of the country contracted by as much as 75 percent to dollar 2.15 billion during July-December, 2019 due to a notable reduction in imports and a modest growth in both exports and workers' remittances. Capital account also continues to strengthen with decent inflows of foreign portfolio investment and foreign direct investment. As a result of these favourable developments, forex reserves held by the SBP rose from dollar 7.28 billion at the end of June, 2019 to dollar 11.73 billion as of 17th January, 2020 - an increase of dollar 4.45 billion - and SBP's short liabilities fell by dollar 3.82 billion in the first six months of FY20. This is despite the repayment of dollar 1.0 billion international Sukuk in early December, 2019.
A closer look at the Monetary Policy Statement (MPS) would explain that the SBP is very much concerned about the continuity of inflationary pressures in the economy and does not want to reduce the policy rate unless there is some concrete evidence of softening of price pressures. As it is, recent inflation outturns have been on the higher side and CPI inflation has risen further to 12.7 percent and 12.6 percent (on y/y basis) in November and December, 2019, respectively. The rise in inflation seems to reflect sharp increases in selected food items on account of temporary supply disruptions and upward adjustments in administered prices. The risk of double digit inflation in the coming months continues to haunt both the fiscal and monetary authorities of the country due to severe criticism by the opposition parties and public at large. The recent hike in the prices of wheat and sugar in the domestic market has added to the worries of the government and undermined the confidence of people in the ability of the SBP to keep inflationary pressures in check. In a situation like this, there was probably no alternative for the SBP but to keep the policy rate unchanged. In order to blunt the criticism of the policy rate to be on the higher side, the MPC has even gone to the extent of saying that "real interest rates on a forward-looking basis were not high compared to other emerging markets and from the perspective of Pakistan's own experience." The MPC is also concerned that "if sustained, high food price inflation could lead to demands for faster wage growth and to possible risks of a wage-price inflation spiral." If such a vicious circle really comes into play, it could have severe consequences for economic and social stability of the country. The SBP also seems to be prepared to revisit its earlier growth projections and revise them downwards due to a marked decline in agricultural production and LSM sector. A depressed growth rate will not only fuel inflationary expectations but would dampen the prospects of improvement in the living standards of ordinary households. Keeping all these factors in view, the central bank felt compelled to maintain the current stringent monetary stance to bring inflation in the desired range of 5-7 percent in the medium to long term.
It is good to see that fiscal and foreign sectors of the economy are moving fast in the right direction. If this was not the case, the MPC would have been under greater pressure to increase the policy rate further to contain inflationary pressures, improve foreign sector accounts and neutralize the impact of an expansionary fiscal policy. The developments on the external sector are particularly encouraging. The C/A deficit which was threatening the solvency of the country when the PTI government came into power has almost been reduced to a sustainable level and this is indeed a great achievement. This coupled with the EFF agreement with the IMF has opened the door for foreign investment and increased the flows of portfolio investment sharply. Although the SBP seems to be pleased with rising foreign investment in government securities and is convinced that inflows at current levels represented only limited risks, yet we have to be more careful about these kinds of inflows because of their disruptive impact in case foreign investors decide to leave the country due to one reason or the other. Besides, the MPC was of the view that recent portfolio investment reflects international investors' improved perception of Pakistan's credit worthiness. In our view, this is only partly true and the sudden inflows of portfolio investment could be largely attributed to relatively better rate of return on investment in Pakistan compared to other countries. Fiscal developments during the current fiscal have also been quite positive. Tax revenues have increased, current expenditures have been controlled and PSDP allocations have risen sharply to boost economic activity and reduce unemployment. Seen from another angle, current fiscal developments and the gains in the external sector are enough to indicate that monetary policy is no more hostage to the imperatives of other sectors and is likely to be eased when the inflation outlook takes a turn for the better.
Under the circumstances it is therefore obvious that the SBP is focused solely on insulating the economy from hyper inflation and is unwilling, as it feels it would be inappropriate, to reduce the policy rate despite pleas by the productive sectors of the economy and also some independent economists. It is therefore up to the government, particularly the political leadership to address the woes and concerns of the people at large in an effective and meaningful manner. One of the best ways of doing this is to take people into confidence. The prime minister is therefore required to address the nation and explain the policy options that his government was confronted with when it assumed office. Under what compulsions was the present economic plan finalized and what were the possible consequences of not embarking on the present plan and how very compelling it is that we stay the course?
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