KARACHI: The State Bank of Pakistan said that when inflation is high, the fiscal policy and monetary policy must collaborate to reduce demand-side pressures.The SBP raised the policy rate by 100...
KARACHI: The State Bank of Pakistan (SBP) said that when inflation is high, the fiscal policy and monetary policy must collaborate to reduce demand-side pressures.
The SBP raised the policy rate by 100 basis points last week, bringing it to 17 percent. “There is a need for fiscal policy to work in tandem with monetary policy to curtail demand-side pressures when inflation is high, expansionary fiscal policy dilutes the impact of monetary tightening,” said Fida Hussain, director monetary policy department of the SBP in a recent podcast. “Therefore, adhering to planned fiscal consolidation under the current circumstance would support the SBP’s efforts to curb high inflation.”
The monetary policy decision has implications for businesses and consumers and therefore is very important for all stakeholders. Providing the justification and main factors for the recent monetary policy decision, he said that there are three important factors that the monetary policy committee has mentioned in its statement.
The first factor is the elevated level of inflation, which slightly decreased from 26.6 percent in October to 23.8 percent in November and stood at 24.5 percent in December 2022. Not only headline inflation but core inflation has also been on a rising trend for the last 10 months, indicating the presence of some demand-side pressures as well as the second-round impact of earlier energy and food price increases.
Furthermore, inflation expectations, among both businesses and consumers, have drifted upwards. The MPC noted that if the central bank did not act in the current situation, these expectations may contribute to a further rise in inflation going forward, he added.
The second important factor in the Monetary Policy Committee (MPC) decision is that the near-term challenges to Pakistan’s external sector and its outlook have increased, despite the sizable reduction in the current account deficit. The SBP’s foreign exchange reserves are declining due to scheduled repayments, while expected inflows have not materialised as planned due to uncertainty, both internationally and domestically, according to Hussain.
The third important factor, the podcast highlighted, are the uncertain global economic conditions. Currently, the global economy is undergoing a slowdown and there are indications that some major advanced economies may experience a recession. This global environment poses downside risks to the outlook for exports and remittances and at the same time may benefit inters of lower commodity prices and ease in global financial conditions.
For instance, a slower pace of increase in interest rates by advanced economy central banks may help revive capital flows to emerging and developing economies and make it easier for them to tap international capital markets. Going forward, we expect to benefit from slightly declining commodity prices and if this trend continues, it will have a positive impact on our imports and the current account balance, it said.
With regards to food inflation, the podcast highlighted that during the winter months of November and December, the shelf lives of food products tend to increase, leading to improved supplies and therefore lower prices. However, this was not the case in 2022, as food prices have risen sharply; this indicates the need for active price monitoring at the local level and administrative measures to ensure smooth and continuous supplies. The higher food inflation and core inflation, if allowed to entrench, create the risk of a wage-price spiral, and therefore necessitated a tight monetary policy response, according to the podcast.
Concerning the impact of rising interest rates on economic activity, it is pertinent to mention here that the SBP’s primary mandate is ensuring price stability. High inflation makes it very challenging for consumers and businesses to plan their savings and make investment decisions, which would affect growth prospects. In this context, the SBP recognises the short-term costs of monetary tightening for economic activity, but also believes that curbing inflation now is essential for ensuring sustainable growth over the medium to long-term, it explained.
The potential inflationary impact of fiscal and exchange rate adjustments was also reviewed by the MPC. The MPC analysed different scenarios envisaging the impact of various likely adjustments, on which the information was available at the time of the meeting, it noted.