Greater the imbalances, harsher the measures that the policymakers have to resort to stabilise the economy and so is the case with monetary policy planners. In its meeting held on 30th November, the Monetary Policy Committee (MPC) of State Bank of Pakistan again decided to raise the policy rate by another 150 bps to 10 percent effective from 3rd December, 2018. The reason for this hike is that although Current Account (C/A) deficit has shown some early signs of improvement, it is still too high. Other near-term challenges to Pakistan’s economy also continue to persist with rising inflation, an elevated fiscal deficit and low foreign exchange reserves. Average inflation during July-October, 2018 was recorded at 5.9 percent compared to 3.5 percent in the corresponding period of last year and this trend was even more pronounced in the case of core inflation. Overall inflation during FY19 is projected by the SBP in the range of 6.5-7.5 percent as against the annual target of 6.0 percent. Economic activity is also expected to witness a notable moderation during FY19. The slowdown in commodity producing sectors is expected to limit the expansion in the services sector as well. In this backdrop, SBP expects GDP growth for 2018-19 at slightly above 4.0 percent or considerably lower than the actual growth registered during the previous year.
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On the external front, the situation is somewhat hazy. During the first four months of the current fiscal, import growth has decelerated, exports and workers’ remittances had increased and the C/A deficit had narrowed to dollar 4.8 billion from dollar 5.1 billion in the corresponding period a year earlier. Despite these positive developments, forex reserves held by the State Bank had fallen to dollar 8.1 billion as of 23rd November, 2018 from dollar 9.8 billion at the end of June, 2018. However, the SBP is somewhat optimistic about the second half of FY19 because of the availability of deferred oil payment facility from January 2019 onwards, recent decline in international oil prices and the expectation of higher foreign inflows. These developments were likely to reduce pressure on SBP’s foreign exchange reserves.
In the monetary sector, there has been higher credit expansion in the private sector, budgetary borrowings from the SBP have increased and almost all liquidity in the banking system has been generated through an increase in NDA. Going forward, the MPC is of the view that inflationary pressures have to be checked, real interest rates remain low, current account deficit was still high, fiscal deficit needs to be reduced and “unfolding global developments, particularly the gradual but consistent normalization of monetary policy in the developed economies demands proactive domestic monetary management.”
We feel that MPC has given the right reasons and made a strong case to tighten the monetary policy by a substantial margin. Although the government and the business community may not like the decision of raising the policy rate by 1.5 percent in one go due to increase in debt servicing and higher cost of production, there was no alternative for the monetary authority of the country but to resort to the most potent instrument of monetary and credit control, i.e., policy rate, which could check the price pressures building up in the economy. It needs to be noted that price stability is the prime responsibility of a central bank and it has to use all its tools to fulfil its duty. Some analysts could argue that a rise in the interest rates could hurt growth but a sustained growth could only be ensured in an environment of monetary stability. Of course, no central bank could afford to reduce or keep the policy rate unchanged when inflation is on the up, fiscal policy is not supportive, external sector gap is too wide, forex reserves are dwindling fast and government borrowings from the central bank are growing rapidly to give further push to inflationary pressures. Availabilities in the economy as measured by the GDP growth could soften the price pressures but unfortunately, the GDP growth is also projected to be much lower than last year and domestic availabilities cannot be supplemented by imports if foreign exchange reserves are low to hardly meet the basic necessities of the economy. Another adverse factor is the worsening fiscal deficit (expansionary fiscal policy) which could put further pressure on prices. The increase in tax revenues during the current year so far is barely 6.5 percent, down from about 8 percent of the last two fiscal years and much lower than the target, fiscal deficit for the first quarter of FY19 was 1.4 percent (annualized 5.6 percent for the whole year), or well above 4.9 percent projected by the previous government and 5.1 percent announced by the present government in its mini-budget on 18th September.
The situation on the external sector, though slightly better than what it was last year, is still not satisfactory. A current account deficit of dollar 4.8 billion in July-October, 2018 means that if the current trend continues, it could nearly rise to dollar 14 billion and cannot be financed through the available forex reserves. The SBP is expecting a reduction in international oil prices and an increase in foreign flows to support the balance of payments but these developments are uncertain and cannot be relied upon to help the external account balance in a major way. Looking back, the previous government had followed almost disastrous policies in the external sector and relied so much upon external borrowings at higher rates to maintain the existing level of reserves and ensure certain level of exchange rate of the rupee that it will take a long time to correct the imbalance in the external sector.
(This news/article originally appeared in Business Recorder on December 3rd, 2018)