Harsh tightening

In a move that took everybody by surprise, the Monetary Policy Committee (MPC) of the State Bank of Pakistan (SBP) has decided to hike the policy rate by a whopping 100 basis points to 16 per cent from 15 per cent, bringing it to the highest level in more than two decades. Clearly, the central bank is worried about entrenched inflation and looking to hit the markets’ inflationary expectations hard. As the latest economic data shows, the economy is in the grip of a stubbornly high and rising inflation in the face of everything the bank has done so far. In October, headline inflation rose by almost 3.5 percentage points to reach 26.6 per cent year-on-year while core inflation rose further to reach 18.2 per cent in rural areas and 14.9 per cent in urban areas. These trends were clearly driven by a massive 35.2 per cent year-on-year rise in energy prices and an even higher 35.7 per cent rise in food prices. All in all, it is plain to see that we are experiencing broad-based inflation. The momentum has picked up sharply, reflecting a 4.7 per cent month-on-month rise in October. This has meant, among other things, that earlier inflation projections for FY2023 have been revised upwards.

The SBP move is largely in line with the global trend of major central banks raising policy rates to dampen the stubborn inflation that has threatened to devolve into a stagflation for some time. A large component of our domestic inflation comes from imported inflation anyway as we spend huge amounts of money on fossil fuel imports. An added impetus this year has come from the cataclysmic monsoon floods that wreaked havoc on housing, agriculture, and industry. In particular, supply chain disruptions caused by this disaster are still at work to distort our food markets, feeding into inflationary expectations to disastrous effect. Another key source of inflation is the rupee’s weakness, and there is no doubt that the local currency remains under pressure based on both large outflows and moderating inflows. The treasury spent $1.8 billion on repayments in November, and is ready to fork out $1 billion on the repayment of a Eurobond issue on December 2, three days ahead of its maturity date of December 5. The central bank says they have lined up inflows within the first week of December to offset this shock to the country’s foreign exchange reserves. A $500 million liquidity injection is to come from AIIB on Tuesday. It is heartening to see the SBP assert that repayments on the country’s debt obligations, especially on commercial debt, will be made on time. The trend of contracting remittances is in particular worrisome, and the authorities would do well to look into the possibility of some remittances migrating to the grey market owing to the yawning gap between the interbank and curb market.

The MPC says inflation is likely to be more persistent than previously anticipated, and expects it to fall towards the upper range of the 5-7 per cent medium-term target by the end of FY2024 – but only if supported by prudent macroeconomic policies, orderly rupee movement, normalizing global commodity prices, and beneficial base effects. This may be just another way of saying inflation has become entrenched, and that the MPC will continue to take countermeasures to cut it to size in the foreseeable future. All of this makes economic sense and as such the course of action plotted by the MPC must be supported. However, the authorities must consider people's plight, in particular the salaried class and wage earners for whom life has already become a stagflationary hell. While there is not much they can do about imported inflation, they must act now to bring down food inflation to stem the rising tide of hunger. Expanding safety nets for the poorest of the poor and administrative measures to monitor food prices to prevent hoarding and profiteering are the obvious candidates. The federal, provincial and local governments must work on a war footing to iron out market supply chain disruptions of the domestic food market, possibly plugging in supply gaps by imported foodstuffs where deemed necessary. The SBP is sticking to its forecast of 2 per cent GDP growth for now, but it is difficult to see how the current policy rate hike can fail to dent economic growth. Considering that 2 per cent growth is effectively contraction for a population growing at around 3 per cent, they may even consider a qualitative easing in the wake of this harsh monetary tightening to keep the economy on a growth trajectory.