In its January Monetary Policy Statement (MPS), State Bank of Pakistan (SBP) was very clear about inflation and policy rate. It clearly said that a temporary supply side shock is possible and the existing accommodative stance of monetary policy remains appropriate to support the ongoing recovery. It is aware of a possible inflationary condition, which is quite manageable.

Since Central Bank’s inflation target ranges between 7% and 9%, there is still no risk for inflation to surpass 9% and it is likely to end up below 8.7% by the end of current fiscal year. Targeting 7% in its January MPS, which is the lower side of the SBP band, was not a convincing number in view of the fact that food and oil prices were volatile and sharply up, which is still a cause of worry.

It is understandable that the SBP is required to walk a fine line amid discussions with the International Monetary Fund (IMF). But it will surely have to strike a right balance to cool down the belligerent market sentiment that anticipates early change in its monetary policy stance. For the future policy rate guidance, the Central Bank can use its forward guidance tool to commit that early lift-off is not possible unless it decides to bring about a change in its stance.

SBP will also be required to indicate to the money market/fixed income dealers that no rate hike will be coming in May or possibly beyond, as inflation is expected to remain within the targeted band.

Further, SBP can use its monetary tools by not draining excess funds from the inter-bank market. It will be required to accept REPO funds at lower cut-off. Moreover, it will have to keep the market liquid to bring about stability.

A sharp surge in bond yields does not reflect a true picture of macroeconomic fundamentals. The pace of surge of bond yields is too fast, which is adding burden on the government’s finances. It can slow down growth and hurt stock market. RDA is doing well, but foreign investors are hesitant to re-enter equity market.

The yield curve of government bond that gives a hint about the country’s economic behaviour is steep, which has to get back to normal because it is putting immense pressure on domestic debt financing.

Right now the economy may look stable mainly because of growth in remittances and corrective measures taken to improve balance of payment position, but it is not generating sufficient profits to meet the country’s desired funding needs. Higher oil prices and the risks associated with cotton and food shortages could spoil the hard-earned gains on the external front.

However, there is a price the government has to pay for slashing imports, as two-third of the revenue collection is generated through indirect taxation, which is one of the major causes behind lower revenue collection. It will remain problematic until taxation issues are addressed and corrected.

In comparison to imports, exports appear to be doing fine, but their growth size is not enough to pay and settle the external borrowing.

Recent tax data shows that tax collection has improved, but it is not enough to reduce the size of domestic borrowing or deficit financing. Yes, Covid-19 could be a spoiler, but we need to get our act together.

The recent upward movements in domestic commodity prices clearly suggest the absence of a fiscal response. Fiscal deficit target, too, could be a hurdle.

Rupee/USD

Interestingly, after three months, SBP has updated REER for the month of January, which is 95.3177. RDA and remittances are providing a huge support. Majority of the economic numbers are supportive. Current account position is also quite satisfactory.

In my December 31, 2020 write-up I had projected that rupee would be hitting to the lower band of 155. Since my target has been met, I am further lowering my projection 152 per USD, as there exists room for further 2% gains.

However, the situation demands an aggressive fiscal stance. Monetary policy does not control the fiscal mismanagement. Proactive fiscal measures will be key to fuelling growth and taming inflation; in other words, a combined effort is required. Any hike in policy rate before the first quarter of the next fiscal year will inflict damage on the ongoing effort. A rate cut of 1% will surely suit the economy.

(The writer is former Country Treasurer of Chase Manhattan Bank)

Copyright Business Recorder, 2021