MPS losing its gloss?

Monetary policy announcement is increasingly becoming a bland activity; as the policy is announced bimonthly and the practice was adopted a decade ago when the volatility in international commodity prices was high to warrant a more regular review. But, for couple of years, the markets are stable amid the prices are depressed to make less reasons of such a regular review at home.

Nonetheless, it’s good to have a frequent review to refresh the economic happenings and to reassure the SBP’s view. And in order to make monetary policy statement effective and interesting with consecutive seventh review of no change in the policy rate, the MPC has to be innovative in its decision making. It has to have more on policy making than simply just adjusting the interest rates, if required. It has to have advocacy on prices and altering tax rates on certain products to manage domestic demand.

The institution used to be innovative a few years back; but with increasing control of ministry of finance on the SBP, the role of monetary policy is reduced and lately the statements, on a first glance, look like a press release of the ministry of finance.

All said, the economy is not doing bad. Growth is picking up and is broad based visible from the pickup in private credit and robust LSM, construction and consumer growth. The supply glut in food commodities is keeping inflation subdued. The international oil prices have gone up and their partial pass on to the domestic petroleum prices are posing inflationary risk whilst fresh round of regulatory duties can bring imported inflation. The inflationary outlook is not scary as headline number may hover in range of 4.5-5.5 percent for FY18; the real interest rates are positive and likely to remain in positive territory in near future. Hence, by merely looking at inflationary outlook, it makes sense for doves to dominate. But the problem is the growing external imbalances and is in the mandate of the SBP to manage external account. The current account deficit has more than doubled in 1QFY18, and was as high as 4 percent of GDP in FY17. The foreign exchange reserves are depleting and the government and the SBP are, for the time being, relying on short term borrowing to not let reserves slip too fast. That is a right strategy; but it should not be prolonged. The need is to be proactive in monetary policy to manage foreign exchange market. The problem is that imports are too high and at the higher base they are growing too fast to make any improvement in exports and FDI is too less to make a meaningful impact.

Thus, curbing imports are imperative for sustainability of the external account. But there is a caveat as imports are for meeting domestic demand and expansion in the economy for meeting future demand. Upbeat domestic demand or consumerism is the heart of the ongoing growth momentum and any efforts to curb it can halt the growth momentum and may have an adverse impact on employment generation.

It is a catch 22 situation. One option is to let the currency depreciate by 5-10 percent, which is propagated by economists whose tilt is against the incumbents, the theory is that it may help exports to grow. Yes, that might be true, but, only in short term. And this step may curb imports, across the board which is great. But the unintended consequence of such step is bringing double digit inflation home and halt the growth momentum.

Another option is to do nothing and let the crisis hit the economy. The timings could vary, in case of any external price shock, it can happen within months, or it may take a year or two to happen, if the trade gap keeps on widening. In that case, we have to revert to the IMF and depreciate the currency by 10-15 percent and get back to low growth and high inflation era. Of course, no one wants this scenario. That is why a few economists are advocating for action today to avert a crisis tomorrow. But too much of action today can invite crisis home.

Is there a third option? BR Research opines there is. A combination of 3-5 percent depreciation in currency, curbing petroleum consumption by increasing taxes, some regulatory duties on non-essential imports (already done), and diverting the money from these steps to swiftly release the refunds/cash rebate to exporters. Concurrently, reach the international debt market for Euro and Sukuk bonds to replace growing short term debt. The SBP has to advocate the government to be innovative and find a midway between two extremes. Let’s hope the new finance minister or economic council to take some warranted actions.