As anticipated by this newspaper, the Momentary Policy Committee (MPC) of the State Bank has again opted to keep the policy rate unchanged at 5.75 percent for the next two months. Justifying its stance, the SBP reiterated the point that "macroeconomic environment remains conducive to growth without impacting headline inflation." Favourable initial estimates of major crops, a healthy growth in credit to the private sector and growing productive imports indicate solid gains in the real sector while headline inflation decelerated in July-August, 2017 on the back of adequate food supplies and stable international commodity prices. The pursuit of higher economic growth, however, poses challenges including those arising from pressures on the external front and an expansionary fiscal policy. Based on current projections, GDP growth is likely to reach the annual target of 6.0 percent for FY18, leading to an improved capacity to accommodate a rising demand.
Average CPI inflation eased to 3.2 percent in July-August, 2017 compared to 3.8 percent in the corresponding period of last year. However, the core inflation, reflecting the underlying demand pressures in the economy, continued to be at a higher level of 5.6 percent in the same period. Average CPI inflation was, nonetheless, expected to remain below the FY18 target of 6.0 percent. Changes in monetary aggregates indicate a growing demand in the economy. Led by historic low interest rates and growing construction activity and consumer durables, demand for credit had picked up. This bodes well for healthy credit off-take for another year. Higher growth trajectory had generated complementary external sector pressures and Current Account (C/A) deficit during the first two months of the current fiscal year had widened to dollar 2.6 billion. The higher imports of productive goods like machinery and petroleum products were strong enough to offset the impact of healthy growth in exports and workers' remittances. The impact of higher financial inflows was, however, not enough to manage the higher current account deficit. Looking ahead, there are anticipations of gains in exports on account of favourable global economic conditions, improvement in domestic energy supplies and incentives given to export industry. While exports present an encouraging picture, imports too are expected to rise due to CPEC-related investments and domestic economic activities. "Hence an improvement in the country's external account and its foreign exchange reserves relies upon timely realization of official financial inflows along with thoughtful adoption of structural reforms to improve trade competitiveness in the medium-term," the MPS concluded.
Although the Monetary Policy Committee (MPC) has tried to give some positive spin to the variables affecting its policy decision, it is quite clear that, under the circumstances, it would have been better to raise the policy rate somewhat rather than sticking to the rate that has been maintained since May, 2016. The underlying pressures in the economy as measured by core inflation (non-food-non energy) continue to be at a higher level and this was also visible from IBA-SBP's Consumer Confidence Survey of September, 2017 which shows a modest rise in expected inflation during the next six months. Demand pressures in the economy are building up. While demand for credit is picking up, monetary aggregates also indicate a rising demand in the economy. Credit growth to the private sector has picked up to 21.1 percent on 15th September, 2017 as compared to 7.7 percent on 16th September, 2016 reflecting a massive rise of Rs 892 billion during the year. While demand pressures in the economy are strengthening, availabilities in the economy are not likely to increase in an equal measure. GDP growth rate in Pakistan is likely to be constrained by a dismal saving rate while foreign investors continue to be shy due to a host of factors, including growing political uncertainty, poor infrastructure and confrontation at borders. A low interest rate also encourages the households to invest in speculative activities like real estate and stock exchange which are not that productive.
The most compelling reason for raising the policy rate was, however, a great deterioration in the balance for payments. The current account deficit of the country last year was over dollar 11 billion and stood at dollar 2.6 billion during July-August, 2017, suggesting that the deficit could be nearly dollar 15 billion during the current fiscal year and well over the target fixed for 2017-18. However, the MPC has not been very forthcoming in its statement to highlight this issue which would have called for an increase in the policy rate. It has only said that a healthy growth in exports and workers' remittances and financial inflows are not enough to manage a higher current account deficit. Obviously, if this is so and the deficit continues to be wide, the country will be constrained to continue borrowing heavily from outside sources at higher rates of interest which will increase the external outstanding debt of the country drastically. By keeping the policy rate unchanged, the SBP has made the holding of rupees less attractive and given an incentive to convert the Pak rupees into foreign currencies, exacerbating the external sector situation further and putting more pressure on the rupee rate. The pattern of increasing dollar deposits with commercial banks in the recent past is an indication of the coming events if the monetary and exchange rate policies of the country are kept unchanged. By keeping the policy rate unchanged, SBP has in fact brought the date of reckoning forward to 2017 instead of mid-2018.