State Bank of Pakistan Puts Cart Before Horse

In the latest Monetary Policy announcement, contrary to the market expectations, State Bank of Pakistan (SBP) has announced hike in policy rate by 25bps to 10.25%. Some analysts were prompt to term this hike as calibrated policy response by the central bank; others term it blind following of International Monetary Fund (IMF) mantra. The rate hike confirms continuation of ongoing monetary tightening on the instructions of IMF. Surprisingly, lack of concrete policy action on the fiscal leaves monetary tightening as the only policy tool to address challenges. As a result of persistent recent hike in policy rate the monthly inflation is likely to be on a higher side, as the impact of utility rate hikes, latest round of rupee depreciation and higher government borrowing from SBP fully sets in. Analysts expect headline inflation in 2HFY19 to surpass 8%YoY as against around 6% in 1HFY19.

It is a bit surprising that the financial experts seeking inspiration from the west have not offered any criticism on the persistent hike in interest rate and depreciation of rupee, but Awami National Party (ANP) having roots in rather less developed areas of KPK province have voiced serious concern over massive depreciation of rupee against US dollar, which they claimed would open floodgates of inflation and the entire burden would be transferred to the common man. They also raised concern that unbridled inflation resulting from devaluation of the rupee was also a cause of serious concern for the business community. They said that despite the perturbed situation, Pakistan Tehreek-i-Insaf government was asking the people not to worry about the currency devaluation.

It is a growing concern that in an environment of uncertainty, the situation is being exploited by the traders who are overcharging the consumers under different pretexts. The real cause of concern is that rise of dollar to all-time high and it would have devastating impact on the economy.

According to one of the reports by AKD Securities, this hike is not a deal-breaker in terms of raised cost of borrowing. Apart from profitability, this cycle of monetary tightening raises risk free rate assumptions, essentially pushing up the required rate of return for equity investors. From an investment perspective, funds flows away from equity and towards risk-free debt instruments could hasten. Reportedly during June 2017 to November 2018, over Rs109 billion flew to money market funds and Rs74.36 billion out of equity funds were recorded.

Tariq Bajwa, Governor, SBP while announcing hike in the policy rate, explained that the Monetary Policy Committee had noted that the impact of the government’s stabilization measures were gradually unfolding and that consumer confidence had improved amidst reduced economic uncertainty. In the same breath he also said, “But the fiscal deficit is yet to show signs of consolidation despite a reduction in spending on Public Sector Development Program (PSDP).” One completely fails to understand the logic that reduction in PSDP can help in containing fiscal deficit. The spending on PSDP is aimed at bringing efficiency and reduction in cost of doing business.

One is also astonished to read his inadequacy, “A marked shift in the pattern of government borrowing from scheduled banks entails inflationary concerns,” adding “Even as stabilization measures gradually work through the economy, underlying inflationary pressures persist.”

Bajwa said that although a marginal increase in exports and healthy growth in remittances had helped contain the current account deficit, “it still remains high”. He add, “The financing of the current account deficit nevertheless remained challenging as foreign direct investment, private loans, and official inflows were insufficient to completely finance the deficit.”

“Thus, a significant part of the current account deficit was managed by using the country’s own resources, which reduced the State Bank’s net liquid foreign exchange reserves to US$7.2 billion by end of Dec 2018,” the central bank chief explained. One is also surprised to read his strange logic, “Realization of bilateral official inflows in the last few days has helped increase the country’s foreign exchange reserves to US$14.8 billion as of 25th January 2019.”

It may be most appropriate to remind the Governor Bajwa that the foreign exchange coming from Saudi Arabia and UAE is debt, which has to be paid off sooner than later, it is an artificial life line. It is also feared that a substantial portion of this debt will be used till the Government of Pakistan (GoP) and IMF agree on a bailout package.

Some of the analysts have been saying for long that instead of following IMF recipe the GoP must come up with some grown plan. Usually an IMF bailout plan demands, imposition of new taxes and/or increase in the rate of existing taxes  hike in interest rate, withdrawal of subsidies, increase in electricity and gas tariffs and worst of all devaluation of currency.

It may be appropriate to remind Governor Bajwa that Pakistan’s economy is heavily reliant on imports (bulk compromising of energy and food products), industry is working on borrowed money and farmers suffer from exorbitant interest rate being paid to informal lenders. Hike in interest rate and depreciation in rupee value put the cart before the horse.

 

 

 

 

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