Space available warrants no meagre rate cut

State Bank of Pakistan (SBP) will announce its monetary policy stance for the next two months tomorrow. SBP took an easy stance last time. In all likelihood this stance is likely to persist. However, SBP’s new policy rate is likely to give answer to some basic questions: (a) Will it remain on course within measured response ie, a cut of 50 basis points as already indicated by the Finance Minister during the spring meeting, of the World Bank/IMF, in Washington?; (b) Will SBP’s Central Board like to be pro-active and opt to be ahead of the curve and cut policy rate by 100bps; and (c) Will it be aggressive and help in kick-starting the economy since the space for a larger cut is available – as inflation is subdued and according to FBS data yoy CPI inflation is at 4.8 percent?

One thing needs to be clarified that with SBP’s policy rate at eight (8) percent is less relevant as the blue-chip corporates are borrowing at 10 to 11 percent – the gap being lenders’ administrative cost. So to kick-start construction activity and help spur growth – a more aggressive cut would be needed.

SBP’s Central Board of Directors would vote on the recommendations of its monetary policy sub-committee based on data provided by the staff of the Central Bank. At the time of rate cut, it needs to be understood that cleansing of the financial system has to take priority. Public debt has stabilised and is going down at best at a slow pace. Debt owed by the government to SBP has come down; however, the injection of liquidity by SBP through its open market operations is continuing. So the old debt is being repaid by creating new debt and the government at 63 percent of GDP is still in breach of the Fiscal Responsibility Debt Limitation Act (60 percent) and would continue to remain on higher side for the next two to three years. Credit to private sector continues to fall and banks are largely investing in sovereign bonds. Money supply which has a direct bearing on inflation is “slightly high”, ie, 7.3 percent of GDP (Rs 730 billion) as against 7.1 percent of GDP, last year, in the corresponding period. This shows that monetary contraction, desired by the government, to correct the monetary overhang of previous years would need to persist. Inflation has come down from double digits (11-12 percent) to a single digit of 4.8 percent. This indicates that the space for real interest rate to remain positive despite a bigger cut is there. Future projections of inflation will be determined by the administered prices of energy – electricity tariff and gas tariff. And, the extent of tax collection on POL products. This would depend on government’s decision to keep import of POL prices at 100 dollars instead of SBP’s estimate of 65 dollars a barrel. If this happen then, inflation in the country would rise. Similarly, if SBP lets the PKR parity to slip to Rs 110 instead of under Rs 102 to a dollar there will be a spike in inflation rate to over six (6) percent.

One can only hope that these issues ought to have been debated at the last Monetary Fiscal Board meeting, held recently in Islamabad. The direction of the macroeconomic numbers may be correct but the pace and correction are very slow. Monetary injection will rise if revenue collection fails to meet the target or if the forex reserves’ projections are below target.

Has the monetary policy become ineffective? Why is KIBOR below SBP’s policy rate? Perhaps the SBP’s corridor (window at which banks borrow or temporarily deposit with SBP) needs a tweaking? Has the market already determined the rate cut and worked it in the quoted rates for government paper? Is the government taxation policy such as withholding tax on cash withdrawals having an adverse impact on deposit mobilisation of banks (Rs 700 billion rise in money supply includes rise of Rs 325 billion of hike in cash-in-hand)? These questions need answers.

All the talk of deflation needs to be understood in the right context. Business sentiments can change quickly if the policy mix is not right. There are infrastructure challenges which need to be met. A fall in exports and an uptick in imports, despite a fall in import of POL, need to be focused on; and some kinds of fiscal measures need to be taken to help make our exports competitive. Therefore, under normal circumstances SBP needs help in building forex reserves. However, Ministry of Finance also needs to be helped in removing constraints which are hindering manufacturing and agriculture output. Market expectations indicate a continued softness in prices of POL and other commodities. Thus, Ministry of Finance fixing inflation target of six percent year after year (at least for last three years) shows an unrealistic target setting. Missing the growth target due to constraints in the economy underscores the need for doing things differently. For a start, let us stop working backwards from fiscal deficit agreed with the IMF, and stop target setting for revenue collectors. One can have expectations but they need to be realistic. Repeated slashing of targets of FBR, year after year, shows that the initial target setting is always wrong and this mechanism needs to change. The economy of this country is connected to the region and the world at large. Pakistanis do not live in isolation; nor do people of any other country. SBP needs to live up to the expectations of citizens if it wants to continue to enjoy their respect.