MPS 2020

The first monetary policy statement (MPS) for the year 2020 announced by Governor State Bank of Pakistan maintained the discount rate at 13.25 percent (since July 2019) dashing hopes of a downward revision that independent economists as well as members of the business community were strongly urging the Prime Minister to consider by arguing that a lower rate was critical to raising the growth rate in the stalled economy.

Reports indicate that prior to his visit to Davos to attend the World Economic Forum Prime Minister Khan had summoned a couple of well regarded independent economists to seek their views on the state of the economy. They maintained that there was a need to tweak three policy decisions. First, reduce the discount rate as it was simply too high. And while the rate did attract hot money, over 2.5 billion dollars to-date, which may be providing support to the rupee yet the Prime Minister was warned that attracting hot money is not considered a desired source of foreign currency and the focus must be to jump start the productive sectors, particularly export oriented sectors, through reducing the cost of borrowing.

However the burden on the economy with respect to hot money inflow is akin to Ishaq Dar's flawed policy of heavy reliance on debt equity (Sukuk/Eurobonds for five and ten years) which have begun to mature during the Khan's tenure raising Pakistan's demand for foreign exchange considerably. Additionally, Dar era sukuk/eurobonds envisaged a rate of return from between 6.5 to 8.5 percent (well above the international average) but well below the current discount rate with a 5 to 10-year maturity period while the hot money inflow could leave the country at the press of a button on the computer.

Secondly, they reportedly told the Prime Minister that revenue target agreed with the International Monetary Fund (IMF) was simply too high envisaging 700 billion rupee additional tax collections in the current year and 900 billion rupees additional taxes next year - a revenue target unrealistic in both years given the projected growth rate. The bulk of additional tax collections in the current year have been from further burdening the existing tax payers. Shabbar Zaidi, Chairman Federal Board of Revenue, is on record as having stated that the heavy reliance on industry for revenue collection is unfair and inequitable and reports indicate that while the number of filers has risen significantly yet the amount of additional revenue collected from the new filers has been insignificant because a large number of those not required to file (widows, students, pensioners) submitted their returns to take advantage of lower withholding tax on purchase of services/goods.

A source of concern which was not discussed is the undervalued rupee (which as per SBP data was at last count in November 2019 overvalued by over 4 percent) which in turn has raised input costs of raw material and semi finished imports (including imports of petroleum and products with negative implications on the poor and vulnerable through a significant raise in transport costs of perishables and other goods and services not totally attributable to a rise in the international prices) by focusing on the rupee stability in recent months. Data suggests that depreciation of each rupee vis a vis the dollar adds 100 billion rupee to the government's debt which, so lament the opposition, is being laid at their doorstep.

And finally, the way forward, the independent economists emphasized, is through renegotiating or tweaking of the agreed Fund programme particularly with reference to adopting a more phased approach rather than the upfront approach agreed by Pakistan's economic team leaders.

Undoubtedly, raising interest is the usual monetary policy tool to check inflation but this is mainly limited to developed and well documented economies and not economies where there is profiteering, considerable smuggling across thousands of miles of porous borders with countries - two of which are actively hostile, no flawed official data (deliberate or otherwise and the recent wheat price data claiming 40 rupee per kg is being termed deliberate) accounting for flawed Economic Coordination Committee decisions (the wheat imports allowed recently expected to arrive when the Sindh wheat crop is in the market changing the supply position is another flawed decision). Last but not least, appallingly poor management of utility companies' that accounts for passing on the buck to the consumers and announcing higher rates retrospectively for losses incurred. An example is the reneging on the part of the government to provide 7.5 cents per unit all inclusive to the industrial sector.

The monetary policy statement maintains that the decision to keep the discount rate at 13.25 percent was taken due to the following three positive factors: (i) current account deficit has declined with orderly conditions in the foreign exchange market after the transition to a market based exchange rate system continued to strengthen the country's external accounts. An undervalued rupee has fuelled market uncertainty in the domestic investment market and the country's trade deficit has declined due to a massive decline in imports; while exports have risen only marginally in dollar terms which in spite of claims to the contrary no doubt prompted the announcement of new incentives - an additional 100 billion rupees for long term finance facility to include all export sectors (less than half the discount rate - at 5 to 6 percent) and 100 billion rupees for export refinance scheme. This would reduce profits of the SBP, with negative implications on the budget, while raising private sector credit at heavily subsidized rates though whether it would raise exports remains to be seen; (ii) IBA-SBP survey shows business confidence is rising for a third successive wave, however at the risk of being facetious the government needs reminding that its attack against the Transparency International's ranking in the corruption index for Pakistan was on the grounds that it was merely a perception. Be that as it may, the survey reveals an unusual occurrence notably the three indexes did not move in the same direction thus while current economic and consumer confidence indices declined the expected economic condition index rose marginally from 46.4 in November 2019 to 46.6 in January 2020. In addition one wonders what led to this perception given that the quantum of large scale manufacturing as per the Pakistan Bureau of Statistics data continues to show a negative trend; and (iii) fiscal developments remained on track and in line with commitments made under the IMF supported programme, buoying overall economic sentiments. The SBP perhaps needs reminding that the target set with the Fund at 5.5 trillion rupees has already been revised downward to 5.23 trillion rupees and this new target suffered a shortfall of 118 billion rupees during the first six months of the year.

While acknowledging that one of the major responsibilities of a central bank is to control inflation the statement notes that "inflation outturns have been on the high side....the current monetary policy stance as appropriate to bring inflation down to the medium term range of 5-7 percent over the next six to eight quarters." Inflation at 5 to 7 percent would therefore not be achieved for at least the next year and a half to two years and that achievement would be subject to inflation outturns no longer being on the high side - outturns that include the high discount rate, an undervalued rupee, poor governance of utility sectors, failure to reform the tax structure by generating revenue from the rich rather than from the existing tax payers, reducing the current expenditure that envisages a raise of 30 percent in the current year's budget, inability to check ongoing corruption leave alone instituting strong cases against those accused of corruption in the past, and last but not least not focusing on growth by implementing upfront IMF conditions that require an immediate renegotiation.

To conclude, the contractionary monetary policy appears to have little control over inflation, especially food inflation, though its impact on productivity is evident while the under valued rupee is raising prices. The contractionary fiscal policy is throttling economic activity while the unrealistic revenue target agreed with the Fund is further dampening economic activity. There is therefore an urgent need for renegotiating/tweaking the upfront IMF conditions agreed by the economic team leaders and one would hope that the visiting IMF team takes cognizance of these concerns during the second mandatory review commencing from today.