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Policy imbalances

The Monetary Policy Committee (MPC) of the State Bank of Pakistan has announced it policy for October and November. It has kept the policy rate unchanged at 5.75 percent. While doing so, the Committee has issued a Monetary Policy Statement (MPS) generally expressing satisfaction on the economic outlook.

The MPS says: “Macroeconomic environment remains conducive to growth without impacting headline inflation. Favorable initial estimates of major crops, a healthy growth in credit to private sector and growing productive imports all indicate solid gains in the real sector. On the back of adequate food supplies and stable international commodity prices, headline inflation decelerated in the first two months of FY 2018. The pursuit of higher economic growth however poses growing challenges partly enunciated at the start of FY 2018. These include those arising from pressures on the external front and an expansionary fiscal policy” (emphasis added).

While we agree with the optimistic assessment in the first part of the above paragraph, the last sentence is the key to understanding the state of the economy. Before analysing it, let us also point two other, more elaborate references to this caution.

First, while noting the rising economic activity, the MPS states: “the higher trajectory of economic growth has generated complementary external sector pressures”. Second, when summing up the bottom line in the balance of payments, the MPS remarks: “an improvement in the country’s external account and its foreign exchange reserve relies upon timely realization of official financial inflows along with thoughtful adoption of structural reforms to improve trade competitiveness in the medium term”.

To summarise, the MPS, while underscoring growth momentum, has cautioned against external account pressures and the problems caused by an expansionary fiscal policy. But for improvements in external account and foreign exchange reserves, it has placed the responsibility squarely on official inflows.

There are five comments we would like to make on the MPS:

First, we agree with the decision of the MPC to maintain the policy rate on the solid ground that inflation remains timid and that a low policy rate is spurring growth – as reflected in a significant uptick, year-on-year, in the credit for the private sector, which is on the back of a handsome growth in deposits.

Second, the assertion that a “higher growth trajectory has generated its complementary external sector pressures” is not tenable. Ex ante, there is no reason why this should happen.

As has been argued previously on these pages, a current account deficit is not a bad thing for a growing economy as it is net external savings that supports a higher rate of national savings and consequently a higher level of investment. The trouble arises when the country does not have enough foreign resources to finance it or does so by drawing down on its reserves. To prevent this, prices must move to clear the market.

Third, even though the expansionary fiscal policy has been noted as one of the causes, it would have been instructive if the mechanism through which it is impinging on external account were also highlighted. In this regard, poor revenue performance, higher expenditures, elimination of provincial surpluses, reemergence of the power sector’s circular debt and the failure to adjust administrative prices (eg electricity) could have been underlined as most of these had an impact on higher imports and thus contributed towards building pressure on Forex resources.

Fourth, it is curious to note that the responsibility of mobilising external resources has been laid at the doorstep of the government in the form of official inflows “along with [the] thoughtful adoption of structural reforms to improve trade competitiveness in the medium term”. Since structural reforms, admittedly, will have an impact in the medium term, the only operative part of this recommendation relates to the provision of official inflows.

During the prevalence of the IMF programme and apart from its own support, the IMF had also facilitated policy (programme) loans from IFIs and the reforms programme acted as a strong signal to the international market that helped raise $4.5 billion in the forms of bonds and sukuks. In all likelihood, such support would not be readily forthcoming – or at least not on favourable terms and in amounts needed to close the financing gap.

In the presence of significant imbalances in fiscal and external accounts, expecting policy-based loans would be unrealistic. In the absence of such official inflows, it would be unwise to let the imbalances persist. Rather than waiting for official inflows, it is time to allow market forces to correct the imbalances. Even a signal to this effect would have profound consequences for clearing the market.

Finally, it would have been appropriate if the MPS had noted the contingency of the oil price shock as the month of September saw the highest price in two years (going above $58/barrel) before sliding down. An oil price shock would only exacerbate the imbalances.

The economic buoyancy visible in the country faces downside risks because of the above imbalances. The results of the consumer confidence survey reported in the MPS further reinforces positive economic sentiments. All predictions point towards an economic growth of as high as six percent during the year. This economic turnaround, after nearly a decade, has been made possible by the wide-ranging reforms implemented between 2013 and 2016. The recent improvement of more than 10 places in the competitive ranking by the World Economic Forum is again a testimony to the fact that deliberate efforts were made to create an enabling environment for investment and growth. It is imperative that the reforms momentum is restored before the country is pushed towards another vicious cycle of fits and starts.

The writer is a former finance secretary. Email: waqarmkn@gmail.com

Waqar Masood Khan, "Policy imbalances," The News. 2017-10-03.
Keywords: Forex