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A stitch in time saves nine: MMPS today

The State Bank of Pakistan is scheduled to announce today a Monetary Policy Statement (MPS). Most market analysts feel that the rate will remain unchanged at 9 percent. They premise their argument on the commitment given and approved by the International Monetary Fund: “A negative impact on economic activity will be ameliorated by structural reforms and more accommodative monetary policy early in the programme,” implying that monetary tightening will begin in FY15 and 16. We feel, however, the LoI needs to be studied with the performance targets given in the attached memorandum as well as technical memorandum of understanding attached to the Letter of Intent (LoI) to grasp the true implications of the programme.

The targeted floor for Net Foreign Assets is steep even after adjusters are applied and SBP would need to purchase dollars once again, as it did under prior action before approval of the stabilisation programme. Similarly, the NDA ceiling is to be adjusted downward if government delays disbursements for PSDP schemes, in any quarter – an old bureaucratic tactic. This implies government has to fund its budgetary shortfall from either privatisation or raising domestic revenue. Proceeds from 3G license auction and Coalition Support Funds received are to be discounted.

The single largest call on the budget expenditure is debt servicing. 85 percent of government”s domestic debt is held by the banks. As such, auction yields of government paper need to be watched closely for future lending rates. On the average, in the last few years, government has been trying to obtain 10 percent more funds in the auction account than the maturity amount to be paid back. And, SBP has been providing the liquidity to banks to fulfil the government needs through OMO injections in the guise of liquidity management. In case SBP does not do this the lending rates in the country would skyrocket and payment system could be jammed.

We argued, before the release of LoI document, that inflation will go up because of cost-push factors and policy rate intervention can only dampen demand-pull effects. Therefore, change in SBP”s policy rate is irrelevant at the moment. But that was before Pakistan was put under the microscope of performance and monitoring under the programme. As such, we now need to be forward looking.

It is estimated that inflation will definitely in double figure by end of FY14; even though CPI in August is around 8.55. Prices of both sugar and cotton in the international market are inching up but so is the import price of wheat. We also know the impact of policy rate intervention take effect with a time lag of six months. So instead of being reactive, SBP now needs to be proactive and raise its policy rate in small spurts rather than give market a big shock four months from now. SBP can average out the rate increase and keep its policy rate positive.

The Fund penalised Pakistan and made it pay for past sins before disbursing the first tranche. SBP bought 325 million dollars instead of 125 million dollar under the prior action agreement from the market and depreciation was more than what the government desired. In effect, IMF engineered the demand for dollars without getting into a discussion on rupee parity vis-a-vis the greenback. It could do the same, in later part of FY14, when the average CPI will be in double digits for the year. So let raise the rate ourself to keep the façade of SBP”s independence. After all, Governor Yaseen Anwar has also signed off on the LoI along with Finance Minister Ishaq Dar. SBP for once can be pre-emptive strategically speaking. 100 bps rise now will give businesses time to adjust and save them from a 200 bps shock in November.

Abu Adnan, "A stitch in time saves nine: MMPS today," Business recorder. 2013-09-13.
Keywords: Economics , Economic issues , Economic policy , Economic growth , Economic planning , Economy-Pakistan , State Bank , SBP , Pakistan