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Macroeconomic choices for 2022

State Bank of Pakistan (SBP) increased policy rate by 1 percent (100 basis points) to 9.75 percent. This is the second increase by SBP within the period of a month (on November 19, the central bank increased policy rate by 1.5 percent). While SBP seeks to curtail aggregate demand pressures on imports and in turn current account deficit through increasing the cost of capital, such aggressive policy rate increase in such a short span of time will, on one hand, add to the cost of production and already high commodity prices, and on the other, government’s interest payments liabilities.

And all of this will happen as poverty and inequality have most probably increased due to pandemic-led recessionary consequences, and a severe commodity price shock. So, when the economy needed such aggregate demand to create enough economic recovery to undo the impact of recession and diminishing purchasing capacities of the masses, efforts to dampen aggregate demand will be counter-productive to the overall economic recovery, will add to cost-push inflation component in a developing country where inflation is a fiscal phenomenon.

On the fiscal side, the upcoming mini-budget announcements are likely to add to efforts to curtailing aggregate demand, and reduce the much-needed stimulus and development expenditure, while on the other hand, over-reliance of government on indirect taxes is likely to hurt appetite for greater domestic investment, in addition to contributing to high imported inflation component and in turn raise commodity prices further. So, when there is a need to have a loose monetary and fiscal policy for economic recovery, reducing inequality and poverty, aggregate demand is being curtailed, and an international aggregate supply shock is not being managed adequately by providing adequate subsidies, and reducing prices through greater intervention in the foreign exchange market, lowering indirect taxes, and improving governance for better functioning of markets.

In the broader and more consequential context, given the limits of macroeconomic policy instruments usage at disposal with developing countries like Pakistan, and steep stimulus-providing-needs generated for government in the wake of the longevity of the pandemic and the hurdles to economic recovery due to vaccine inequality, it is imperative that financial support from rich, advanced countries, and special drawing rights (SDRs) allocations by the International Monetary Fund (IMF) are enhanced significantly for developing countries, which are also net importers of oil and drastically challenged by the consequences of fast-unfolding climate change crisis.

Moreover, Pakistan is in an IMF programme, and continued procyclical emphasis of IMF conditionalities/recommendations has left policymakers in a difficult situation during the pandemic to deal with current account deficit, and also make necessary stimulus/development expenditures. So, rather than pursuing with procyclical policy stance, the IMF needs to show strong appreciation of the limits of policy tools available with policymakers in both creating enough fiscal space for managing the negative consequences of pandemic and international commodity supply shock on economy, and its spillover into possibly making the current government unpopular, and hence support the country through enhanced allocation of SDRs in safeguarding foreign exchange reserves, allowing the country in turn to better manage current account deficit in a way that needed imports for economic recovery are sustained and the economy is better insulated imported inflation.

Instead, it is pushing government towards pro-cyclical policies – reduced subsidies overall, rather than increase them overall and better target them, enhance revenue collection and with greater pace – which clearly shows that while IMF high echelons boast of showing understanding for the important need of providing stimulus and adequately spending in health and overall economic recovery, at the operational level remains quite vociferous in pushing programme countries towards policies that lead to greater austerity. The role of the US Congress is also important here, which could provide higher ceiling with regard to SDR allocation, through legislating accordingly. Even without such enhanced allocation allowance by the Congress, the IMF still has a lot of space to be less demanding on programme countries with regard to conditionalities that push towards pro-cyclical and austerity policies.

The main economic choice government needs to make is to whether it wishes to carry out an economic recovery that reduces inequality and poverty through adopting counter-cyclical policies even if it means leaving the current IMF programme, which means not overly focusing on curtailing current account deficit and diminish any chances for broad-based economic recovery at the back of higher cost of capital, production, imported-inflation led price shock, and debt-liabilities, or to seek the path of more aggressive economic diplomacy for arranging greater financial support, especially in terms of enhanced SDR allocations and climate financing and through smart curtailment of imports and much-improved governance of markets.

The IMF also has an important economic choice for 2022, and that is to understand the limits of policy instruments’ usage by developing countries, and come to the same page with regard to its lofty public announcements of supporting developing countries’ stimulus and development expenditures needs during the pandemic on one hand, and changing its quite contrary operational policy pro-cyclical emphasis with programme countries. Rich, advanced countries also have an economic choice to make towards developing countries, and that is to either see them slide towards a debt pandemic and climate disaster, or to provide adequate finances, and show greater role in changing the multilateral frameworks that allow for better tackling vaccine inequality, developing countries balance of payments and climate-financing needs.

Dr. Omer Javed, "Macroeconomic choices for 2022," Business Recorder. 2021-12-17.
Keywords: Economics , State Bank , Central bank , Commodity prices , Economic recovery , Fiscal policy , Macroeconomic policy , Monetary fund , IMF , SDR

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