Earlier in 2017, when economic stresses were building with excess demand reflecting in the external account, the SBP was behind the curve and did not tighten the monetary policy to curb demand. Today in 2019, with the economy chocking with excess supply all around, the SBP is again behind the curve and tightening the already suffocating economy.

World over, the central banks look for three elements in deciding the monetary policy - asset bubbles, wage inflation and output gap, to gauge the gap between supply and demand. Or other policy instruments are used to manage demand. Price shocks- such as high commodity prices are usually transitory and central banks give less weight to them in deciding the policy course of action.

In Pakistan, lately the central bank has been too late in reacting to ground realities - earlier it was the political pressure of PMLN government, to not tighten the policy when it was most needed. And now, the IMF pressures are compelling the SBP to go for excessive tightening. Neither of the untimely actions is good for the economy.

The demand pressure started reflecting from October 2016, when the current account deficit started widening as economic demand was generated through asset bubbles - both in stock and real estate markets, and fiscal stimulus. The stock market grew 46 percent in dollar terms in 2016, and the returns in real estate were even more mouth watering. The wealth effect was created and people started spending more money on higher perceived value of their assets.

The economic push was primarily on government spending with developing spending at an all time high of 5.26 percent of GDP or Rs1.68 trillion in FY17. During PMLN time, the average annual development spending was 4.71 percent of GDP versus 3.9 percent of GDP in PPP times and 3.6 percent of GDP in Shaukat Aziz time. The higher fiscal spending was creating demand across the board.

Thus in 2016-17, wages were growing decently, and the economic demand was upbeat while a few sectors were in process of expansion. At that time, reserves to deplete fast due to excess imported demand, and the pressures were becoming visible on the fiscal side too. The SBP was required to curb the demand. But the first rate hike took place in May 18, and even that seemed like a token move.

Now in the past few months, excessive monetary tightening, steep exchange rate adjustments and significant cut down in development expenditure along with energy prices adjustment have already significantly slowed down the economy. There is no asset bubble that exists today. The stock market is down - the market capitalization fell from as high as $99 billion in May 2017 to as low as $54 billion today. The real estate market is in shambles too.

The wage inflation could be negative, as across the board, in various industries, there are evidences of nominal cut in salaries and layoffs. People are adjusting household spending as imported inflation is creeping in while the income is not growing, if not falling. Such situation does not make a case of monetary tightening.

The third factor is output gap. There is supply glut in the market - cement, steel, wheat, sugar, automobiles and many other sectors have excess capacity. The private sector credit is growing as there are inventories in the system. There is a clear case of supply greater than demand. How is a monetary tightening policy to curb demand justified?