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SBP shocks but doesn’t surprise

Even those shocked by the SBP’s (State Bank of Pakistan’s) uber-hawkish posturing at the last MPC (Monetary Policy Committee), like businesses and investors, had more or less priced in a pretty hefty hike; some even 150 basis points according to some estimates. So nobody was really surprised.

But talk of more tightening down the road is already pretty surprising because it means SBP is ducking the one or two questions that everybody is asking. It’s clear enough that inflationary pressures are principally supply-side so demand destruction, on top of the squeeze from the fiscal side in the form of less subsidies and more taxes, can be marginally beneficial at best. It would be another matter if political considerations forced expansionary fiscal concessions out of the government, of course, but since Miftah Ismail has no qualms about a surgical implementation of very austere IMF (International Monetary Fund) ‘prior conditions’, SBP ought to at least quantify what it hopes to achieve by making credit unnecessarily expensive just when the biggest challenge is to ramp up production and exports and encourage foreign investment.

The monetary policy statement was full of worries about the external sector, specifically the so-called commodity super-cycle that’s driven up energy and food costs to multi-year highs. Not that increasing interest rates is the best way to deal with this situation, since it also adds only to the cost-push part of inflation, but surely the country’s central bank can see that King Dollar at a two-decade high, Dr Copper and other important industrial metals dropping, and Chinese demand fluctuating because of Covid imply an imminent plunge in Brent. That ought to take the pressure off the external side for a while, at least, and also show in the SBP’s forward messaging.

Maybe Deputy Governor Murtaza Syed wants to do something on the lines of what Governor Dr Reza Baqir did not too long ago. As he pushed up rates when the rest of the world, especially bigger economies with more stable currencies, were very dovish, he encouraged what is called the carry trade, which broadly involves using a high-yielding currency to fund transactions with a lower yielding currency. That’s what drove wave after wave of hot money into the system and drove up the rupee, giving the impression that IMF’s man in the Bank magically turned the currency around.

But this time it’s very different. Interest rates are on the way up all over the world and most serious investors would rather wait till the dust settles before committing money to volatile markets. Besides, Sri Lanka’s decision to stop payments to foreign bondholders earlier this year, followed by Russia’s technical default because of sanctions, has triggered a feverish debate about a quarter-trillion dollar distressed-debt pile that is threatening to push countries with similar problems, which according to Bloomberg includes El Salvador, Ghana, Tunisia, Egypt and Pakistan, into one default after another.

If a couple more emerging markets with sovereign debt trading at distressed levels fold, you’d have contagion on the lines of the Latin American debt crisis of the 1980s on your hands before you know it. Already, the Fed raising rates feverishly, the strengthening dollar, and the subsequent difficulty for developing countries to meet bond payments, is eerily reminiscent of that debacle. These are times when investors rush away from, not towards, such places. Since carry trade also comes with monumental risks, it’s not a very likely proposition at the moment.

This is also precisely when such countries need to grow out of their problems. But when your economic lifeline, which in our case is resumption of the EFF (Extended Fund Facility) with the IMF, demands an extremely, even cruelly, restrictive fiscal policy to kill demand, and the monetary side also feels obliged, for some reason, to chip in with sanctions of its own, where’s that growth going to come from?

It would, all said, be very surprising to see the Bank stay on this path at the next MPC. After all, tightening the belt beyond a point begins to hurt what’s inside the tummy and makes it difficult to digest the food. And then nothing in the whole system works right.

Shahab Jafry, "SBP shocks but doesn’t surprise," Business recorder. 2022-07-14.
Keywords: Economics , State Bank , Fund Facility , Interest rate , Monetary policy , Debt crisis , Central bank , Foreign investment , Reza Baqir , Sri Lanka , Pakistan , SBP , IMF , GDP , EFF , MPC

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