Confronting the crisis

LAHORE: Full autonomy of the central bank demanded by the IMF is not possible. Even in the most advanced economies central banks are independent within the government.

It is the responsibility of the federal government to generate resources through tax and non-tax measures to run the state. The central bank simply checks the flow of money through its monetary policy.

But there is no way to separate the fiscal and monetary policy – one affects the other. The fiscal policy is determined by the federal government and monetary policy comes under the domain of the central bank.

The economic targets are fixed by the federal government and the central bank is expected to regulate its policy in such a manner that facilitates the government to achieve those targets. When the federal government is starved for funds it has three options.

The first is to raise the taxes. This is a politically very difficult option particularly in countries like Pakistan where even the genuine upward adjustment in petroleum product rates based on global prices (we import petroleum products) earns displeasure of the electorate and the opposition.

The other option is to borrow from commercial banks or foreign countries/multilateral institutions.

The domestic banks are always ready to lend the government any amount it likes. The loan is risk-free and payment is guaranteed by the state at 1-3 percent premium on policy rate.

The third option is to ask the central bank to print notes. All these government decisions have some drawbacks. When the government exercises any of these options, the central bank tries to reduce the adverse impacts of these decisions through the monetary policy.

Obtaining heavy loans from the domestic banks, crowds out credit for the private sector. Moreover, it is inflationary in nature.

The central bank has an option to let inflation go up or check it by increasing the policy rate. It also however increases the cost of government borrowing. Private sector has also to pay correspondingly higher mark-up.

Thus, price of manufacturing items increases. In the end, the rise in prices again triggers inflation.

If policy rates are kept stable, inflation can spike, but the cost of borrowing of the government remains stable within the budgetary projection.

Inflation however also weakens domestic currency, which can be checked through higher policy rates. It is an uphill task to strike a balance that causes minimum economic damage.

Borrowing from friendly countries has an immediate positive impact, but the long-term borrowing cost of the state increases. On the other hand, loans from multilateral institutions are subject to certain harsh conditions, such as demand to increase taxes, electricity and gas tariff, as well as rates of petroleum products.

Since these conditions are politically difficult to accept, the central bank is asked to increase policy rate and devalue the currency. These conditions are extreme and trigger general price hike and slowdown in the economy.

Most governments back out of agreements with multilateral donors in the middle. No economy has ever improved once a country after taking harsh steps for the first few tranches backs out of the agreement.

It is here that the federal government exerts its pressure on the central bank to ease its monetary stance and not toe the lender’s line.

The third option of printing notes instead of obtaining loans is highly inflationary.

Malaysia during the 1997 East Asian crisis refused the IMF recipe and managed its economy through this option. In Pakistan, the PPP government during 2008-13 used this option that increased inflation and devalued the rupee initially, but the economy slowly started improving after a very brief stint with the IMF programme.

In the last two years the central bank has been toeing the IMF. It was only after Covid-19 that the bank moved towards a more balanced monetary policy. IMF is not pleased, and businessmen and traders demand further reduction in policy rate.

However, rupee has stabilised and inflation under control. Exports are now rising in line with the central bank’s mandate of giving priority to the exporters. At the same time it has eased import restrictions to facilitate inputs for the exporters.

There has been no progress in consumer financing. The central bank through its monetary policy should discourage consumption that hurt our resource starved economy.

The 60 million middle-class of Pakistan (they have dwindled to 40 percent now) should refrain from wasteful spending.

They should save in the national interest. Only the affluent middle class could increase the national saving rates. The poor do not have resources even to make both ends meet while the lower middle-class hardly pulls on what they earn monthly.

These affluent middle-class families usually lack resources to buy a house or a car on cash. However, these families consume 40 percent of their monthly income on housing and transport.

The central bank has now started facilitating these families to own their house through mortgage finance and consumer financing. The monthly instalments would be around 40 percent of their monthly income.

Consumer financing in Malaysia is 50 percent of its GDP, it is 18 percent of GDP in India and only 2 percent in Pakistan.