The internal Monetary Policy Committee of State Bank of Pakistan (SBP) was unanimous in its decision for keeping the discount rate unchanged and the Board conveniently approved that stance. The government has already gained adequate benefit from a 450 basis points cut in the discount rate during the last 18 months and any marginal benefit from a further rate cut would only reap results after the current government's tenure is over.
The Monetary Policy Statement (MPS) is depicting a bleak economic situation despite successive rounds of monetary easing. This might give some clue of the dichotomy in the aims and endeavours of decision-makers sitting on the Board of the apex regulator.
The graph on the very first page of the thirty one-page Statement reveals the happenings in the banking system, which is the root cause of economic plight. The banking capital and financial flows nose dived while government borrowing from the system skyrocketed over the past five years. This largely explains the unprecedented inflation, low private investment and steep depreciation of currency.
The challenges SBP is facing out of this economic debacle include managing the Balance of Payments (BoP) position and containing the resurgence of inflation. Addressing these challenges necessitates monetary easing. Since these challenges remain; the probability that the hawks eyeing rates cuts will reign supreme again shortly, is quite probable.
SBP recognises the fragility of surplus in the Current Account that is owed in no small part to $1.8 billion-inflow from the Coalition Support Fund (CSF) while pending privatisation proceeds remained elusive. About $4.8 billion have to be paid back to the International Monetary Fund (IMF) over the next seventeen months, so managing the external account seemingly is a daunting task for SBP.
Although the central bank reasserted on Friday that funds for these repayments are accounted for, foreign exchange rates in the open market can be expected to remain volatile, especially when inflation is raising its head again. The agony is excessive government borrowing and dying external flows which have not helped the cause of excessive softening in the past. The average growth of government borrowing for budgetary support in the past four years was around 60 percent, on the other hand, private credit grew by a mere four percent.
This culminated to over 25 percent growth in domestic debt while private fixed investment contracted by 9.4 percent, asserted the MPS. That is why despite 17.4 percent YoY growth in banking deposits, SBP had to continuously roll back liquidity injection. This roll over is not an immediate threat but it is not sustainable, and keeping a pressure on inflation. But it's a political compulsion as there is no progress whatsoever to address the structural imbalances to put reins on fiscal deficit. One way or another banking system either through direct money creation or indirect injections has to positively respond to government's appetite.
The market is greatly cognisant of this fact and is not expecting interest rates to come down further. This is evident from a steeping yield curve. The spread between the 10-year Pakistan Investment Bond (PIB) rate and 6-month Treasury bill rate has increased to 256 bps from 133 bps at the start of this fiscal year. The market is charging premium to invest in long-term owing to political uncertainty of election year and expectations of interest rates to move up the ladder soon.
Keeping in mind all kinds of volatilities in the system, SBP wisely reduced the interest rate corridor by 50 bps to 250 bps. But that is just a symptomatic measure, not the cure to the ailment of high fiscal and energy gaps. Now if only the incoming government can get kick start reforms, the inevitability of another return to the Fund may yield a happier ending than the most recent experience.