SBP has kept the policy rate unchanged. Global commodity prices are in a super cycle. Fiscal policy is absorbing energy prices shock. This coupled with accommodative monetary policy (negative real rates), will lead to more pressure on the currency to absorb shock. However, that has inflationary consequences. SBP and finance ministry seem to be on the same page. The objective is to keep inflation in check during these days of insane pricing.

The inherent assumption is that commodity prices follow a parabolic trajectory i.e., they are moving up from a high base and the fall would be steeper. This may happen. However, the risk is on timing. At current prices, Pakistan doesn’t have external and fiscal buffers to sustain for even four months, which it is feared may move further up in the short term. Given the risk, SBP has indicated in the forward guidance that the MPC is prepared to meet earlier than planned meeting in late April.

Thus, if Russo-Ukraine war continues to unnerve markets, and prices continue on current trajectory, SBP may increase rates in 3-4 weeks. And if prices ease earlier, then SBP may continue with its earlier stance – that the current monetary policy settings are appropriate for the medium-term inflation outlook of 5-7 percent.

The main issue is current account which was recorded at all time high of $2.6 billion in January 2022 and at $11.6 billion in 7MFY22. Earlier, leading indicators of growing current account deficit led SBP to increase the policy rate by 275 bps. Then, currency depreciated from Rs 150-153 to lates Rs 175-78. The impact of these tightening measures is visible on demand.

The trade deficits (especially imports) over the last two months are on decline. High-frequency economic indicators are showing moderation in growth. Agricultural production estimates seem to be on the lower side. Demand is tapering off. SBP fears that further tightening can hamper growth momentum higher than desired. SBP expects GDP to grow between 4-5 percent in FY22.

The question is how effective further tightening could be in suppressing demand to lower the import bill. Rising interest rates may not have any immediate impact on petroleum demand and other energy demand which are the immediate concerns. Here, pricing is the most effective tool.

But that has been sacrificed at the altar of political bickering. That even makes currency depreciation ineffective in the short run.

However, SBP’s actions will lower demand in other areas, which is not desirable. By keeping real rates negative, it creates pressure on currency. The first victim is private capital flows. There are none in debt market and not much left in equity either. Then the parity is based on inflation and interest rates differential. The benchmark is the US where interest rates are near zero despite multi decade high inflation. The theoretical currency pressure doesn’t exist.

Flexible exchange rate in Pakistan is moving on demand and supply of interbank flows. Higher the current account deficit, weaker is the currency. SBP argues that not all current account deficit is the same. There are elements which are fully financed by loans and supplier credit. The market is tight, and there could be gradual depreciation.

SBP under current management has remained bold in the past and didn’t shy to act when needed. To anticipate SBP’s next move, keep a close eye on commodity prices and fiscal responses which are dependent on the highly fluid domestic political situation.