WEB DESK: The Monetary Policy Committee (MPC) of State Bank of Pakistan has once again decided to keep the policy rate unchanged at 5.75 percent.
In its Monetary Policy Statement (MPS) released on 24th September, 2016, it was made clear that such a determination was made on the basis of an uptick in inflationary pressures and the risk of widening current account deficit.
CPI inflation rose to 3.6 percent in August, 2016 from 1.8 percent in the same month last year while average inflation during the first two months of the current fiscal year was more than double than July-August, 2015. According to the MPS, “the expected pick up in domestic demand is largely going to determine the inflation path in the remaining months of FY17”. Uncertain global prices also continue to remain a major determining risk.
Year-on-year increase in broad money was 13.9 percent on 9th September, 2016 as compared to 13.5 percent on 11th September, 2015. Liquidity conditions in the money market were comfortable mainly due to retirement of government borrowings to scheduled banks. Doubts about the behaviour of international oil prices, anticipations about the impact of interest rate hike by the US Fed early in the year, a slowdown in the Chinese economy and the aftermath of Brexit on international financial markets were building up on the prevalent uncertainty.
In the external sector, while the record high foreign exchange reserves have supported stability in the foreign exchange market, current account deficit was at the risk of widening further owing to declining exports and rising imports. As the CPEC-related projects are gathering momentum, economy was projected to expand further. Relatively low prices of inputs, low interest rates and improved security situation are expected to attract foreign investment, boost manufacturing sector and add to sustainability of growth.
A very peculiar aspect of the MPS this time is that it is very brief and to the point. Also, it was already widely expected that the SBP would continue to maintain the present monetary policy stance. The reason for such a reckoning was quite simple: no central bank would take the risk of easing monetary policy and reduce the discount rate if there are apprehensions about strengthening of inflationary impulses in the economy and the risk of worsening current account deficit.
Unfortunately, however, both these variables have tended to deteriorate during the first two months of the current fiscal year and are not expected to improve anytime soon. Inflation, as measured by the CPI and core inflation, was not only up during July-August, 2016 but likely to increase further due to a higher demand because of an increase in liquidity in the economy unaccompanied by a similar rise in availabilities as measured by the GDP growth rate and the possibility of increase in oil prices.
The situation on the external front was even under greater threat. Current account deficit of the country has almost doubled during the first two months of the current fiscal compared to the same period last year and there are reasons to believe that the situation will aggravate further. Trade deficit is widening due mainly to a declining trend in exports, home remittances are stagnating, direct foreign investment has plunged to low levels and bilateral and multilateral inflows are falling. The recent tension at country’s borders and political unrest within the country would of course further damage the prospects of economy, quicken the pace of deterioration in the external sector and put more pressure on prices.
In a situation like this, there was no reason for the MPC of the SBP to consider easing of monetary policy and add to the demand pressures further. The MPS says that the decision to maintain the policy rate at 5.75 was taken after detailed deliberations. We find it hard to understand the reasons for saying this when nobody has ever blamed the SBP’s MPC for the lack of comprehensive discussions before arriving at a policy decision. According to this newspaper, some of the MPC members had wanted a symbolic cut in the policy rate. It would be interesting to know their contention or argument when all the symptoms other than inflation had suggested an opposite policy course.
It could, nonetheless, be argued that the policy rate should have been increased somewhat (again to 6 percent or so) because the present situation is vastly different from end July, 2016 when the previous monetary policy was announced. At that time, the inflation and external sector data for July and August, 2016 were not available and such a level of deterioration in these variables was not expected.
Since the position on these accounts has lately worsened, it would have been rather helpful to arrest the worsening trend in these indicators by raising the policy rate. While this argument may seem to be valid, the MPC of SBP may have preferred to wait and see the evolving situation until the next meeting and this of course was its prerogative. By mentioning this, we just want to say that there could be chances of tightening the monetary policy in the coming months if the present trend in the behaviour of causative factors affecting the policy rate continues to persist. Lastly, the SBP seems to be quite optimistic about the positive impact of the CPEC and the improvement in security situation on the economy. We would also like to think the same way but it is better not to count one’s chickens before they are hatched.
In fact, a contrary argument could also be made that as the next election is getting closer and the IMF would no more be breathing on our neck to undertake the necessary reforms, the policymakers of the country may be tempted to adopt politically expedient measures without caring for the medium or long-term prospects of the economy.
Source: Business Recorder