The reported claim by the SBP Governor and Dr Hafeez Sheikh that the main selling point for a high discount rate is its linkage to the rate payable by the National Savings Centres (NSCs) to domestic savers (widows and pensioners) is also challengeable. True that the rate of return on NSC products cannot be that much higher than the discount rate to ensure that financing institutions are not dis-incentivized from extending credit to the productive sectors and instead purchase NSC products (though barring those lucky enough to access credit on concessional terms with a limit of 300 billion rupees the actual rate of lending is around 18 to 19 percent at present). However, this rationale does not reflect the true picture. Pakistani governments' and the incumbent is no exception, raise NSC rates, a major source of borrowing for the government, as and when they have need of cash. January 2020 data released by the Ministry of Finance and its associated departments showed a shortfall in projected revenue collections and an expected spurt in expenditure (especially with respect to Public Sector Development Programme and social sector development which had received only 8 percent and less than one percent respectively of what was budgeted for the entire year by December) - disbursements which the government committed to the IMF during the first mandatory review report it would release in the third quarter of the year.
And viola! In January 2020 interest was raised on all NSC schemes - to 14.28 percent or 2.40 percent higher on Behbood, pensioner benefits accounts and Shuhada family welfare accounts (with a maximum purchase limit) while return on defense savings certificates was raised by 2.44 percent to11.57 percent (below the discount rate which was 13.25 percent since July 2019 till 17 March 2020); thus the around five-and-a-half-month delay in raising the NSC rates is inexplicable if the linkage between the two rates is irrefutable. Hence the rationale that a high discount rate is to ensure the poor pensioners capacity to sustain their purchasing power is not credible; besides a high inflation rate (14.56 percent in January 2020), lower than the revised rates on NSC products, would have reduced savings, as more was required to meet a householder's consumption needs.
Hot money inflows are linked to a high discount rate though its withdrawal has been just as swift as a consequence of the onslaught of the global pandemic. Since July 2019 when the discount rate was set at 13.25 percent around 3.43 billion dollars of hot money inflows were witnessed though by 20 March 1.35 billion dollars had left the country - 75.645 million dollars from equity market, 1.28 billion dollars from treasury bills and 33.282 million dollars from long-term Pakistan investment bonds. This outflow has not abated and at last count the outflows were estimated at 1.8 billion dollars; and while the reason maybe external to the economy as correctly stated by Dr Baqir, yet the fact remains that economists no longer recommend actively attracting hot money inflows through a high discount rate as its exit can be overnight due to factors external to the economy.
But these outflows are impacting on the exchange rate which, in turn, is raising the debt repayment in rupee terms given that each rupee loss vis a vis the dollar raises debt repayments by 100 billion rupees. Friday past the SBP entered the exchange market to bring the rate down to 164.75 rupees to the dollar in the inter-bank market, a rate reflected in the open market though demand for dollars has not risen appreciably in the open market - an indication of appropriate concern with the impact of an eroding rupee value on other major macroeconomic indicators.
The government must tread with extreme caution as the raise in debt repayments may overtake the Coronavirus package itself. Additionally, Dr Hafeez Sheikh has indicated that the government intends to borrow an additional 1.4 billion dollars from the IMF, on the same terms the ongoing EFF, and has requested other multilaterals for support. The IMF Managing Director released a statement Friday that Pakistan would be eligible from the 50 billion dollar Rapid Financing Instrument.
There is no doubt that Pakistan needs considerable financial assistance to meet the COVID-19 related expenditures. However, it is relevant for the economic managers to keep in mind that debt service repayments as a consequence, would further increase dramatically. And to put this in perspective a quote from International Institute of Finance, is in order: "cumulative outflows since late January have surpassed the levels observed at the peak of the global financial crisis and are an order of magnitude larger relative to the size of the global economy than in stress episodes such as the Asian financial crisis or the taper tantrum."
A high discount rate would keep the current account deficit in check however that has been massively reduced with the balance of trade deficit declining to negative 2.04 billion dollars (July-February 2020) from nearly negative 20 billion dollars when the PTI government took over due to massive import compression and marginal increase in exports in dollar terms. Export orders are now being cancelled due to the recession in buyers of our consumer products due to the Coronavirus. In this scenario, concessional loans to exporters alone are unlikely to be successful in jump starting the economy; meanwhile the other source of desired foreign exchange inflows, notably remittances are projected to decline further due to the virus - 1.84 billion dollars on 20 February 2020 from 1.90 billion dollars in January and 2.09 billion dollars in December 2019 - a decline as countries begin a lockdown including shutting down non-essential businesses/services.
The obvious lesson learned is that it is time to abandon the policy of high discount rate and instead target the rate to reflect domestic production considerations (and not focused on exporters alone or on hot money inflows). The re-linkage of the rate to core inflation (8 percent in February 2020) as in the past needs serious consideration which would imply a rate of 9.5 to 10 percent maximum. Additionally, it is appropriate to induct a couple of former governors of the SBP in the Monetary Policy Committee (MPC) so that critical past knowledge is readily available with which a new inductee may benefit from that, in turn, would enable him to take more informed decisions.
(Concluded)
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