A fine mess

The perfect storm buffeting Pakistan’s economy keeps getting more and more perfect. While Finance Minister Ishaq Dar believes we are through the worst, there is no denying we are in the middle of a fine mess. The rupee resumed its slide from Wednesday first thing Thursday morning, and had lost 6.66 per cent of its value by closing time. This saw the dollar surge by almost Rs19 to reach Rs285.09 at COB. Shortly before COB, the State Bank of Pakistan announced a 300-bps increase in its policy rate, taking it to 20 per cent, in an effort to meet an IMF demand ostensibly aimed at curbing inflation. It bears repeating that coming at an off-cycle MPC meeting, the policy rate review is aimed at the Fund, and has nothing to do with either inflation or the rupee’s exchange rate. The Fund on its part argues the interest rate hike is necessary to stem the rising tide of inflation.

In any case, the twin drives of sliding rupee and rising inflation have pushed commodity prices higher. The Monetary Policy Committee (MPC) called for urgent steps towards energy conservation measures to alleviate pressure on the external account, allowing more space to meet other import requirements. Hefty though it seems, the policy rate hike is unlikely to immediately exert any real pressure on the now entrenched inflation. It will no doubt further depress private lending by pricing commercial loans outside the reach of many more borrowers, but the tightening of money supply will come at the price of the already stalling domestic sector falling into deeper doldrums. Perhaps it will dampen inflationary expectations in the medium term, but real interest rate will remain negative for now. A steeper hike over the past several months would have a better chance at success, but that was not to be, and now we are stuck with what we have.

To be fair, Pakistan’s economy was already in a tailspin after years of gross mismanagement when the coalition government took reins of power in April 2022. The perpetual subcritical political upheaval engineered by the cohorts of former PM Imran Khan has since kept the country at a boiling point, projecting a political risk that keeps investment at bay and economic activity in a hiatus. Come monsoon 2022, Pakistan’s economy was devastated by cataclysmic flooding. The deluge destroyed vast tracts of farmland and washed away road and rail links, triggering a food crisis that is still playing out. Food inflation is in fact a major driver of today’s historic high level of headline inflation. The rupee free fall has clearly taken a hint from the Supreme Court ruling calling for election in 90 days. In other words, the markets took fright at the same prospect that has kept our foreign multilateral and bilateral lenders jittery for the last several months: What if the government falls, and the successive political dispensation declines to honour the commitments it has made? At least it factors majorly in the calculations of the IMF staff, who continue to insist for assurances that an electricity surcharge imposed by the incumbent government will continue in the coming years. Hiking the interest rate looks like the final hurdle in the way of a staff level agreement with the IMF – the final condition of the Fund staff met by the authorities to the hilt. But given how hard a bargain the Fund is driving, it increasingly looks like the government will not get the reprieve it needs to kickstart the economy. The final review of the program will soon kick in, opening the door for another series of bargaining when the government has hardly anything to concede.

The Fund continues to shove one inflationary policy after the other down the throat of a government too desperate to keep its external sector afloat. In hindsight, Pakistan could have invoked force majeure immediately after the flooding disaster, declared a unilateral moratorium on all external debt, and be done with it. Extreme as the measure seems, it could have hardly inflicted more damage to the economy than we have seen since. But the government decided to take the high road, and now finds itself helplessly flailing in the clutches of a cold-hearted lender. The Fund is tight fisted lest Islamabad may spend part of its Western dollar inflows on its Chinese debt accounts. Even after taking into consideration the economic warfare the Western bloc is waging on China, this level of belligerence to an emerging economic power should be beyond the pale, especially when it concerns a country that has historically been a friend of the West and that has never seen its ties with China and the West as a zero-sum game. It is up to the government to decide how to resolve this conflict, but it is clear we need to further broaden our horizons rather than narrowing them down.