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Questions the MPC didn’t answer

There were no surprises at all in the MPC (Monetary Policy Committee) meeting. Parts of the market tilted towards a 125-basis point rise but the SBP (State Bank of Pakistan) had its reasons, one very obvious one, to keep the interest rate below the double-digit psychological barrier. Other than that everything from the content to the tone of the MPS (Monetary Policy Statement) was completely priced in. The market also rose three-hundred-something points ahead of the announcement because it was certain that the hike, ordinarily not the best news for equities, wouldn’t be too outrageous this time.

Global monetary policy has clearly pivoted from easing to tightening over the latter half of 2021. The initial reasons for the general rise in consumer prices were backlogs, base effects and an all-around rebound in activity that unleashed a lot of pent-up demand. And that, since restrictions weren’t completely lifted in most parts, caused supply chain disruptions and strained logistic networks, leaving container ships jammed at major ports. And just as buyers were bidding up prices of limited inventory, commodity prices shot up 56 percent for the year and became the main driver of inflation. Now some countries are at the point in the cycle when consumer behaviour also fuels inflation as people speed up purchases to try to beat price increases, causing even worse shortages.

Emerging market and small country central banks were the first to tighten screws since they are more exposed to exogenous price shocks. In some cases the tightening has been very steep. Brazil, for example, leads the pack with a 725bp interest rate increase since March. And now the only thing keeping all countries from rising rates together, just like most of them raced to zero a little over a year ago, is that some are still not sure that the Omicron variant will not pull the rug from under the recovery. Once more tests confirm that it may be more transmissible but it isn’t more potent, as seems to be the case so far, more will jump on to the bandwagon.

But Pakistan does not fit this pattern. Both inflation and interest rates here were higher than the regional average since before the pandemic. Even after the rapid 625bp reduction, the interest rate was much higher than the global average. And even though Tuesday’s 100bp rise was not as stiff as some expected it to be, SBP is still the most hawkish central bank in Asia. These things raise a number of very important questions that the MPS did not touch upon.

One, was this decision purely market-based or was it another one of those ‘prior actions’ for the EFF (Extended Fund Facility)? The finance ministry has been pretty open about what it’s supposed to do for the IMF (International Monetary Fund), but SBP has not. There certainly have been rumours, not really denied by SBP, that this was indeed one of the demands of the Fund to revive the bailout programme.

Two, the government’s not yet ready to abandon the growth narrative. And more growth will need more exports. But such is our production matrix that more exports require more imports than the current account can sustain without structural adjustment, which is not an option nor even possible in the immediate term. So how does cutting imports, and therefore exports, work when the government wants GDP to grow 5 percent and higher interest rates will bite into production, and hence also exports?

Three, does SBP expect inflation to increase or decrease by the time of the next MPC early next year? November’s reading was 11.5 percent, the highest rate in Asia, much higher than the year’s 7-9 percent target, and initially laughed away by the federal cabinet even though it was reported by the FBS (Federal Bureau of Statistics). But what to make of that part of the MPS where it said that “the aim of mildly positive real interest rates on a forward-looking basis was now close to being achieved” and then went on to say that “MPC expects monetary policy settings to remain broadly unchanged in the near-term”?

If that means the interest rate will not be increased next time, then it must imply that inflation will come down below 9.75 percent. Or does “broadly unchanged” mean that “monetary settings” could be less than broadly changed?

And four, let’s not forget that raising the interest rate also increases the government’s cost of borrowing, which further bloats the deficit and stokes inflation when the money is thrown back into the economy. That’s happening when everything from fiscal stimuli to concessionary lending is being trashed to meet IMF’s demands, the borrowing rate for businesses is about twice that of the rest of the region, SBP has had to increase its own inflation outlook to 9-11 percent for the rest of the fiscal, and the rupee has become the worst performing currency in the region. Considering all this, why hasn’t anybody raised any flags at all about stagflation?

Shahab Jafry, "Questions the MPC didn’t answer," Business Recorder. 2021-12-16.
Keywords: Economics , Economic growth , Monetary policy , State Bank , Consumer prices , Emerging market , Omicron variant , Interest rates , Central bank , Pakistan , FBS , MPC , GDP

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