Policy rate and oil subsidy — I – Opinion

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In its latest Monetary Policy Statement (MPS), released a few days ago, the State Bank of Pakistan (SBP) raised its policy rate by 150 basis points to 13.75%. According to his interview with Bloomberg, published as part of an article “Pakistan-IMF talks going well, taking ‘a little time’: Acting SBP Governor Dr Murtuza Syed said that “.. …and so far in this round of monetary policy tightening that we’ve been undertaking since September, that brings the cumulative rate hike to 675 basis points.

Why did the monetary policy committee take this monetary policy decision? There were basically three main reasons: the first is that inflation has been quite high in recent months, it reached 13.4%, a two-year high, last month it was in double digits in over the past six months, and in In addition, underlying inflation also appears to be high, close to 10%. It was therefore very important to keep inflation expectations anchored. Second, the economy had to do with some cooling.

We’ve actually had a very harsh Covid rebound, the last two years, we’ve had nearly 6% growth both years, thanks to an unforeseen fiscal expansion this year. So from a macro point of view as well, cooling the economy makes perfect sense.

And thirdly, of course, Pakistan has been under pressure from outside, our reserves have fallen, we’ve had quite a large current account deficit, which we’re trying to moderate, and this decision yesterday should help that direction as well.

With a key rate of 13.75% and inflation of 13.4%, the country faces a positive real interest rate. Keeping the real interest rate as positive, in the traditional sense of a developing country (Pakistan) where, in general, inflation is at least also a fiscal phenomenon, and not just primarily a monetary phenomenon, has not much sense, but having it when inflation has been heavily driven by the global commodity supply shock – mainly oil and food – for almost a year now, and accentuated by the war in Ukraine by Russia where oil prices were on an increasing trajectory for several months before that – mainly due to supply constraints as well, in addition to demand which rebounded after the initial phase of containment – ​​does not hold at all.

And to say that core inflation is also rising is to miss the nexus between imported/supply-driven inflation/cost-push that drives almost every sector of the economy, and does not not only evident in the prices of energy and foodstuffs, given the lack of market governance/regulation in terms of both lack of transparency/prevalence of collusive practices which generally do not allow better price recovery and a more justified magnitude of profits.

On the other hand, the 6.75% increase in the key rate since September seems to have contributed to inflation through the cost inflation channel, in turn reducing the purchasing power of a large part of the society.

Indeed, there has been no increase in real wages, including real labor wages in the agricultural sector, and no significant reform of agricultural markets has taken place over the years. , which in turn indicates a lack of more correct price recovery for farmers. in a significative way.

Additionally, rising fertilizer prices, increased running costs for tube wells on oil-fired generators, and the negative impact of an extreme swell wave on the wheat crop, for example, have all meant that there has been no significant and widespread improvement in farmers’ purchasing power.

Furthermore, the high rate of economic growth over the past two years is generally not based on a significant sense of increased level of inclusive growth where, apart from growth in the agricultural sector, about which the above analysis does not indicate much increase in outline. based on the increase in purchasing power, the other main determinant of the shape of large-scale manufacturing does not mean that small and medium-sized enterprises (SMEs) have increased a lot, where the rise in the policy rate to both directly in terms of increased cost of borrowing for SMEs, and indirectly through increased borrowing costs for government, has resulted in the crowding out of a large portion of small businesses/investors, who are faced with a dwindling prospect of subsidized lending facilities under the government-backed programs of the previous government, not to mention the difficulties it may increase to continue to keep the mortgage rate capped at a lower level.

So, instead of increasing the policy rate by 6.75% since September, only one or two percentage points at most should have been increased, given that the main determinant of inflation is the global supply shock. behind the rise in inflation, but also because inflation and the policy rate have a weak relationship in Pakistan considering that the traditional lack of financial depth in the country means that demand-driven inflation does not is only a determinant of inflation, while the cost-driven inflation channel also remains an important determinant of inflation on the back of both imported inflation and weak governance /regulation to reduce market failures/imperfections.

Between January 2018 and May 2019, for example, the policy rate rose from 6% to over 12%, but headline inflation also showed an upward trend, rising from around 4.4% to 9.1 %; where the falling part of inflation has been less acute and for a relatively lesser duration than the magnitude of the rise, both in terms of the magnitude and duration of the rise.

And that was before the global commodity supply shock, which likely only accentuated this weak relationship. Indeed, developing countries, which have a weak financial base to begin with, could also provide little stimulus during the pandemic.

On the other hand, rich and advanced countries which have provided more than $13 trillion to stimulate their respective economies and which have a much more developed financial sector to begin with face both a significant level of drawn inflation by demand, in addition to a significant level of costs are pushing inflation as a result of the global commodity supply shock.

So, unlike developed countries, which need to undertake significant monetary tightening because they seem to have provided more stimulus than needed and remain cautious in their tightening considering that inflation, after all, was also caused by significantly by supply shock, developing countries mainly need counter-cyclical policies and few monetary tightening/austerity policies considering the fact that in developing countries like Pakistan, inflation is currently driven more by a supply shock than anything else.

(To be continued on Wednesday)

Copyright Business Recorder, 2022

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