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Macroeconomic stabilisation

This following argument has been prompted by the State Bank of Pakistan’s rejoinder to an editorial of this newspaper.

This writer is of the view that there are serious questions about the government’s and SBP’s choice of instruments and the intensity of their use to achieve macroeconomic stabilization, as this writer proceeds to argue below.

The approach to seek foreign investments in short tenor government instruments is worrisome because it has led to an appreciation of the exchange rate, making it vulnerable to a nasty shock from any sudden outflow of these funds. Although it is both awkward and difficult to discourage such flows, a better strategy would have been to pick up more dollars from the market to build up the foreign exchange reserves, also thereby shielding the economy from the avoidable outcomes of any abrupt flights of capital.

It is also difficult to appreciate the strategy to attract foreign portfolio investments at interest rates higher than 13% and for durations less than even one year. Considering a relatively stable exchange rate situation Pakistan can still raise longer tenor loans and bonds at much lower interest rates (admittedly in foreign currency), thereby also improving foreign exchange liquidity. Therefore, this approach is exposing us to a double whammy – higher and more frequent payouts (with no liquidity related advantages).

One of the arguments underlying the decision to maintain a higher interest rate regime is that the pressure on the exchange rate will be of a subdued nature. But then what is the difference between this plan of action and the approach adopted by the then finance minister Ishaq Dar – both trying to protect the exchange value of the rupee. At least in his case, while he was running down the foreign exchange reserves to protect the exchange rate, this and the associated policy actions stimulated economic growth whereas growth is being strangulated under the present scheme of things.

Furthermore, if the SBP is pursuing this strategy as a way of forcing banks to lend to the private sector it has not had any meaningful success to date. Private sector borrowings for the year to date have been less than 30% of what was lent to it during the same period last year, and that despite average injections of more than Rs.1 trillion by the SBP over the course of this year.

Therefore, all that the SBP has been able to achieve through its injections is help the banks to invest in government securities and not the private sector if the intent of the injections was to facilitate banks to lend to the private sector. With the real sectors of the economy struggling to survive the banks, fearing a rapid growth of NPLs, would, understandably, be cautious in enlarging their exposure to the private sector.

There is a strong predilection for the use of monetary policy, especially in the form of a high policy rate. And we should be grateful that SBP provides us opportunities to learn new things every day- that interest rates can check both food inflation and the impact on the CPI of increases in administered prices of electricity and gas.

Interest rates are supposed to change behavior. One would like to be enlightened how higher interest rates can check aggregate demand when the principal borrower, the real culprit, is the government whose expenditure obligations are largely inelastic. Moreover, if as an outcome of injections, the net interest cost to government is just 32 paisa one is left wondering why its behavior would change.

Finally, the SBP spokesperson is seemingly arguing that the REER has little policy relevance and merely serves an indicative purpose. Then why is it bothering to estimate and share if it does not influence its policy actions-so estimating it only because this is what it had been doing historically!

I A Hafeez, "Macroeconomic stabilisation," Business recorder. 2020-02-14.
Keywords: Economics , Economic growth , Economic conditions , Macroeconomic stabilization , Exchange rate , Finance Minister , Monetary policy , REER , CPI

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