KARACHI: The State Bank of Pakistan’s chief economist said the central bank paused its monetary policy tightening this month due to a contraction in the domestic demand, impacts of the floods, which could affect the economic indicators and growth, and a stable outlook for inflation.
The SBP kept the policy rate unchanged at 15 percent at its recent policy review held on August 22.
The Monetary Policy Committee (MPC) opted for no change in the interest rates owing to three basic reasons: The first being the desired results of the previous policy rate hikes were being achieved i.e. aggregate demand is being slowed down,” said Dr Ali Chaudhry, the chief economist and the research advisor, SBP, in a podcast on Friday.
“We can verify this by looking at the sales numbers of cement, the auto industry. The demand in the economy has slowed down. Large-scale manufacturing is also slowing. The second reason for taking a pause in the policy rate was the impact of floods which we still do not know accurately but the impact of floods will eventually affect the economic indicators and growth,” Chaudhry said.
He said the SBP would get the initial data related to the impact of floods on the economy in the next four weeks and compare it with 2010 floods, while the third argument was that the SBP was not surprised by the present inflation because the most recent data on inflation suggested that projections on inflation did not need to be updated.
“We have maintained our projections of inflation at 18-20 percent for the current fiscal year,” Chaudhry revealed.
It may be noted that the next MPC meeting is scheduled after six weeks and the exact situation of the economy is expected to become clearer by that time.
The chief economist said it was important to consider the outlook of inflation in the near term, the price of petroleum products in international markets had decreased in the last few weeks, and similarly the price of commodities had also decreased slightly. “Overall, the projections of inflation of SBP remained unchanged.” “Looking ahead, headline inflation is projected to peak in the first quarter before declining gradually through the rest of the fiscal year, according to the SBP’s monetary policy statement.”
Throwing light on the exchange rate regime in Pakistan, he said it was now market driven; when the supply of dollars was greater than the demand and if the sentiments of the market were positive, then the rupee would appreciate at a market-determined exchange rate.
“Likewise, if import payments are high, and there is a demand for dollars, then the dollar will appreciate.”
He also said the most difficult part was behind us now; the cumulative growth of Pakistan was in double digits in the last two years and the economy was overheating to handle it, the SBP had to increase the policy rate by 8 percent very quickly and if we compared this move with other countries, SBP responded in a short span of time.
He highlighted that the sentiments and confidence in the economy mattered a lot and this had been emphasised in the MPS as well and that the IMF programme would anchor confidence in our policies which was a signal of credibility for the economy of Pakistan and through this, “we will also see stability on the exchange rate front”.
Elaborating on the policy rate, he said the decision was taken by the MPC members, which were ten including the Chairperson.
“It comprises of three external economists, three members of the Board, and three internal members of SBP and Governor SBP,” he said adding, “After a lot of deliberations including presentations given by the SBP team on the latest economic indicators and sector-by-sector outlook of the economy, the MPC takes the decision.”
He further explained that this committee is independent of the SBP Board. “Our team has to present all the facts and figures before the MPC committee related to all sectors in a very objective manner, besides presenting the results of Econometric and General Equilibrium models which analyse the whole economy very closely in one piece,” he summarised. He observed the decision of the MPC didn’t necessarily have to be unanimous and if there was a split then the Governor would have the casting vote.
Responding to the rumours about the default of the country, Chaudhry rejected such them as groundless and stated that from now on the country’s economy was poised for an improvement and noted that Pakistan had experienced a demand shock as well as a supply shock from the perspective of oil. He said the impact of demand-side pressure on inflation was almost 60 percent and 40 percent was due to the supply side because of oil and commodity prices.
“The impact of the steps taken in the last few months can now be witnessed as demand for everything has shrunk”, he noted while adding, “It was very important for us as the number one objective of SBP is to achieve price stability and now the SBP’s target was to deliver price stability of 5 to 7 percent in the medium term”. Chaudhry reiterated the SBP’s stance that after the Amendment in SBP Act, the central bank’s job was to deliver price stability.
“Our inflation target is 5-7 percent for roughly eight quarters. As the projection for inflation improves in the future, the policy rate will eventually be decreased along with that improvement.” On the other hand, he said a high level of inflation hurt the demand of businessmen as well. “In fact, such high levels of inflation were not good for economic actors.”
He revealed that at present Pakistan was going through an austerity phase and as projections for inflation improved, the policy rate would eventually be decreased.
“On the flip side, a high level of inflation hurts the demand, and that every contraction is different from the other, be it the IMF-driven or otherwise,” he claimed.
Replying to a question about whether austerity meant reducing expenditures and consumption in line with income, Chaudhry answered there were two ways to address the situation: “either we increase taxes or we decrease our expenditures. These different types of austerities have different intensities for growth; the impact of tax type austerity on economic growth is more as per some recent academic studies due the effect it has on confidence and sentiments. Pakistan generally has used expenditure type austerity and its impact is less and rebounds very quickly”.
