The newly formed Monetary Policy Committee took the right decision by maintaining the status quo on Saturday. However the policy statement did not highlight risks associated with recent macroeconomic recovery. The language of the document was dovish while the hawks dominated in the decision making. Perhaps, the influence of the IMF has worked.
Yes, the second quarter performance was better in terms of higher tax revenues, uptick in development expenditure and influx of foreign flows to ease pressure of fiscal financing on domestic banks which in turn increased growth in private credit and improved LSM growth. The fiscal deficit may not fall by much as higher revenue growth is being offset by uptick in development expenditure. Improvement in all these indicators will help attain a higher growth momentum. For an economy which is in a nascent stage of stability, running both expansionary fiscal and monetary policies is not a great idea, especially when the currency is also overvalued.
Inflation and the Balance of Payments need to be critically analysed through the lens of the Monetary Policy. CPI, on yearly basis, for all three months of the second quarter has increased consecutively, albeit as expected due to low-base effect. The good omen is that inflation is expected to remain subdued in January and February on a monthly basis although yearly inflation will carry on its northward journey to over four percent in February - for the first time in this fiscal.
SBP expects inflation to remain around 3-4 percent in the current fiscal, however BR Research calculations reveal that the central bank is conservative in its approach as yearly average inflation may remain below three percent owing to depressed food and oil prices. However, the signs point to an uptick in demand and eased supply constraints in FY16 which could over-heat the economy and potentially trigger an inflationary environment.
M2 grew by 13 percent between Jan15-Jan16 which; at an inflation of 2.5 percent, signals real monetary growth of 10.5 percent - that is a bit too high and another rate cut could have fuelled it further. Net foreign assets exhibited some growth in the second quarter due to materialisation of bilateral and multilateral flows. In the first quarter, NFA flows were Rs25 billion and by mid-Jan, the flow increased to Rs104 billion. This helped slowdown the growth in fiscal borrowing from banking sources while private credit was negative Rs74 billion in the first quarter, and today the tally is Rs288 billion.
So net growth of Rs362 billion in private credit in the last three and a half months clearly shows the impact of foreign flows. Evidently, monetary easing (400 bps since November 2014) is doing the job. The need is to not overdo it. So a decision to not lower the discount rate further, is the right decision.
The Balance of Payments has not improved much in the second quarter, despite the pickup in NFA. Overall reserves increased by $1,375 million in the first quarter while the growth in the second quarter tamed to $735 million. The global economic slowdown and depressed commodity prices have stunted exports. The country''s exports are down by 11 percent in 1HFY16 and the fall in December (14%) is even sharper. The start of January was not much better as global markets melted further and the slowdown in China''s economy has become more visible. This may put further pressure on Pakistan''s exports.
A fresh round of depreciation of currencies has taken place while the Pak Rupee has remained resilient. PKR is overvalued by all means, except from the lens of Dar. The IMF calculates currency overvaluation of 5-20 percent based on different models. According to the central bank''s REER, the domestic currency appreciation stands at 21 percent. Given this situation, it is imperative that the currency should be adjusted to support exports. Unfortunately, this is not happening and to counter the appreciated currency, high real interest rates are of utmost importance.
Although the imports are falling and may remain low in the near future due to record-low oil prices, a trend of higher machinery imports is building and it will continue in the next two years until the power infrastructure and industrial expansion cycle is complete. Virtually all these expansions and power projects will help attain domestic demand with no or little help to boost exports. This may not let the Current Account deficit fall much and foreign exchange reserve building may not be smooth. Hence to entice net foreign inflows, a tight monetary policy is the doctor''s order.