The International Monetary Fund (IMF) board's approval of 1.386 billion dollars under Rapid Financing Instrument (RPI); 50 percent of Pakistan's quota, together with World Bank's pledge to release 238 million dollars and the Asian Development Bank's to release 350 million dollars, and G-20 countries' decision to extend debt rescheduling to 76 countries that includes Pakistan, created a cushion on the external front that enabled the State Bank of Pakistan for the second time in a month to reduce the discount rate. This time, the Monetary Policy Committee (MPC) of the central bank decided to cut the rate by 200 basis points to 9 percent. The MPC had faced scathing criticism from industry and trade as they felt that it continued to take decisions clearly at odds with those taken by the central banks of other countries. Thus as the world grappled with the virus through a lockdown leading to a stifling of economic activity/production, and a massive decline in aggregate demand the central banks throughout the world brought the interest rates to near zero. However, in the West, credit demand by the general public is significant, a fact that supported the decision to reduce rates during the virus. In contrast in Pakistan, credit demand by households is almost non-existent and the major sectors demanding credit are the government (mainly federal as well as provincial) and the private productive sector. Thus the major impact of a decline in discount rate would be to decrease debt repayments of the government, thereby creating some fiscal space to engage in relief activities.

The SBP report for H1-FY19 does acknowledge that "firms heavily utilized Libor-based foreign currency (FE-25) loans and relied on less expensive rupee denominated loans as well as concessional facility of SBP (EFS)." And it added that "the financial position of non-exporting sectors remained generally weak. In H1-FY19, the firms had leveraged excessively to address their cash flow constraints emanating from inventory build-ups and higher raw material and operational costs."

The question is whether the MPC's decision to reduce the discount rate to 9 percent, still high by international standards, is appropriate though perhaps tellingly it's close to what is being followed by Turkey (9.75 percent) and Egypt (9.25 percent)? The MPC in its statement dated 16 April once again cited IMF projections (world economy expected to contract by 3 percent in 2020), Google's Mobility Report suggesting that there was a significant slowdown in most part of the economy in recent weeks and CPI March and SPI in April showing a marked reduction in inflation momentum as the rationale for a decline in the discount rate.

The forgoing shows the persistence of two elements in the decision to set the discount rate by the MPC: (i) the discount rate would remain linked to headline inflation. This decision has been openly criticised not only by previous SBP governors as well as the business community and independent economists. All critics urged the MPC to restore the linkage between core inflation and discount rate (rather than the post-May 2019 policy decision to link headline inflation to the discount rate) arguing that headline inflation which includes items like petroleum and products, as well as energy that are not a function of the discount rate; and (ii) the 9 percent rate as per the MPC statement "reduces forward looking real interest rates (defined as the policy rate less expected inflation) to around zero which is about the middle of the range across most emerging markets." The claim that this would cushion the impact on growth and employment including easing borrowing costs and debt service burden of households (extremely limited in Pakistan) and firms is unlikely as noted in the SBP half-yearly report cited above.

The reduction in the rate is unlikely to provide the impetus to private sector that is necessary to fuel growth enough to generate output and provide jobs and there is no doubt that the clamour to further reduce the rate and link it to core inflation would gather momentum. The fiscal space created would enable the government to spend more on relief activities; however, that would be subject to the rupee-dollar parity. In the event that it worsens repayment in dollar terms would rise and the pressure on the rupee may resurface in weeks and months to come.