Managing the Money Flow

By keeping its key policy rate at 22 percent, the State Bank has wisely aligned its decision with the trend in developed economies. In order to “bring inflation down to the target range of 5-7pc by September 2025,” the bank correctly argues that it is imperative to maintain a tighter monetary policy stance with positive real interest rates. Despite increasing pressure from the business community to start reducing rates due to the substantial positive interest rates and the slowing rate of inflation, the bank has maintained its position. This indicates that it views the following factors as threats to the near-term inflation outlook: the expected resolution of circular debt in the energy sector amid negotiations for a new IMF program; the expected rise in global oil and commodity prices (as the Middle East situation worsens); budgetary stabilization measures; and the delayed monetary easing by advanced economies.
It’s true that those advocating for rate reductions have a strong case.After dropping by roughly 10 percentage points over the previous three months, headline inflation is expected to stay between 15 and 17 percent for the upcoming year. Positive rates have therefore made space for the initiation of monetary easing. In spite of an improving current account balance, the rupee and foreign exchange reserves remain stable. They also note that although the economy is beginning to recover somewhat from the 0.2 percent contraction it experienced last year, growth is still muted and contributing to unemployment. Due to unprecedented financial costs and loan servicing issues, businesses are in a crisis.According to bank reports, in 2023 bad loans reached a record high of Rs62 billion, the highest in 13 years, due to negative growth in private credit. The counterargument, however, is stronger. Despite hopes for a further decline, inflation is still high at the moment. More importantly, lower rates will spur demand, which will increase imports quickly, put pressure on the currency, and defuse expectations of inflation, making the economic “stability” that has been attained in recent months brittle. Not to mention, the State Bank will need to keep an eye out for how its actions may affect worldwide economic patterns given the anticipated postponement of US rate cuts.Consequently, the bank has acted sensibly by holding real rates significantly positive until all domestic and global inflationary risks have passed, refusing to give in to pressure or temptation for monetary easing.