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Economic notes

March 20, 2020

Seizing the opportunities

Opinion

March 20, 2020

The global turmoil triggered by the Covid-19 pandemic has brought a mixed bag of opportunities and dangers. The massive fall in oil prices has the potential to solve many of the problems affecting the lives of common men.

It can also help ease the burdens associated with the IMF programme. But the turmoil in the PSX and exchange rate market have posed dangers that until recently were believed to be behind us.

In this article, we first assess the likely outcomes being unfolded and their impact on key economic variables. Second, we suggest some measures that would be helpful in facing the emerging challenges.

The declining oil prices will have an all-encompassing effect in the economy.

The import bill would be nearly halved. In the first seven months of the fiscal year (Jul-Jan), the oil and gas import bill amounted to $7.1 billion. At the current prices, it is projected at $9.5 billion compared to $14.4 last year, giving savings of about $5.0 billion. This saving would create liquidity in the inter-bank market which, unless absorbed by the central bank, would tend to appreciate the rupee. The central bank should continue to sweep such money as it did recently in the face of a general reduction in the demand for imports.

The lower oil prices would enable lower prices for consumers. This is the greatest stimulus that the government can help unleash which would lead to improved public welfare as their incomes would rise and, consequently, spending too. The prices would decline in general in the secondary reaction to lower oil prices and thus reduce inflation.

Reduced inflation would allow a much-needed cut in the policy rate which in turn would stimulate the demand for investment and contribute to reduced cost of production for existing businesses. Need for utilities prices adjustment would be lessened and can be deferred for future recuperation and off-setting. Let’s examine the dangers that lurk on the horizon. First, the global slump will affect our terms of trade for exports adversely. Both price and quantity effects would be adverse. Second, the main suppliers of inputs for our exports (China, for example) are facing export disruptions of their own and thus affect negatively supply of exports.

Third, there will be an exit of some of the foreign capital we had encouraged in government securities. The lower return after decrease in the interest rate as well as uncertainty about the evolving situation would contribute to this exit. Fourth, and perhaps most importantly, the response to the coronavirus will have an internal dampening effect as schools and universities shut down, travel restrictions come into effect, and businesses scale back their operations to enable their employees to take the mitigating measures to deal with the virus. Finally, the dampened economy will further slump the growth in FBR revenues. This would pose a challenge to meet the fiscal targets under the IMF programme.

We believe that, on balance, these changes can work in our favour if we carefully craft a policy that would take advantage of opportunities and ward-off dangers. We give a road map.

First, and foremost, the government should make arrangements to pass on the reduced prices to consumers as early as possible. To this effect, the government should not wait until the next cycle of price setting on April 1. This a discretionary cycle that can be set for any length of time. The new price can be announced in a few days to trigger the new scenario of increased consumer spending. While setting the price, the government would be justified in ensuring revenue neutrality by adjusting the rate of GST to off-set potential loss due to lower prices.

Second, the SBP response of cutting the rate by 75 bps has not inspired market confidence. It would be imperative that another MPC is called to reevaluate the ground realities and adopt an interest rate policy that is consistent with market expectations. Clearly, the possibility of an earlier meeting is mentioned in the monetary policy statement and governor’s video message. The bigger rate cut is needed to punctuate the message that would be conveyed by the passage of reduced petroleum prices, which is also getting late.

Understandably, the central bank would be concerned about the effect of a lower interest rate on exchange rate, foreign short-term capital and level of reserves. We believe the interest rate cut, in the backdrop of global turmoil, would have a net positive effect on the economy after all these factors are taken into account.

The exchange rate instability was a result of stock market melt-down as those exiting the stock market found shelter in the dollar. However, a well justified intervention by the SBP in the penultimate hours on Friday restored order in the market.

The exit of foreign capital could well have basis in the global disruptions. The Bank should not be hostage to the so-called ‘hot-money’. As we noted earlier, the import bill would be halved and plenty of liquidity would be available in the market to make up any amount of exit of hot-money. In fact, as soon as some sanity returns to the international capital market, the government should access the market and float Euro Bonds and Sukuks to raise $3-5 billion so that the vulnerability with the short-term money can be removed.

Third, the government has already taken some good measures to support exports and more can be taken in response to the results from these measures.

Fourth, to ward-off the slow-down in economic activities, the government should make good use of the IMF new window as well as relief given on fiscal targets by not counting expenditures on fighting the coronavirus. The government should use the Ehsaas programme to reach out to the poorest people and give them the requisite support needed to survive this adversity.

The prime minister’s speech did not cover the economic agenda to fight the virus, which all other governments have given priority. His response has to start with the passage of low petroleum prices to the consumers which would be a real shot in the arm to rejuvenate the economy. If this opportunity is missed, the melt-down seen in the stock market would spread in other parts of the economy. The time to act is now.

The writer is a former finance secretary.

Email: [email protected]