Economic pause

A shift in market sentiment following the return of veteran Finance Minister Ishaq Dar pushed the rupee higher, which was aided further by the government’s crackdown on the grey currency market, which forced those dollar stashes back into the formal economy.

The recent recurrence of the Monetary Policy Statement is the second in a row to keep interest rates at 15%. This was to be expected. What was unexpected is that, while the latest policy assumes a flood-damaged economy, it remains tight-lipped about how it will help the economy recover from its current situation. The original goal of raising the policy rate to its current level in July and continuing it in August was to cool an overheating economy torn apart by yawning twin deficits. Except that this monsoon’s cataclysmic flooding exerted its own decelerating pressure, it appears to have worked as expected. The resulting demand suppression has tended to moderate headline inflation and improve the current account balance. Lower imports helped to reduce the trade deficit. A shift in market sentiment following the return of veteran Finance Minister Ishaq Dar pushed the rupee higher, which was aided further by the government’s crackdown on the grey currency market, which forced those dollar stashes back into the formal economy. This is fine because it is in line with market expectations.
However, for some reason, the monetary policy fails to adequately account for the impact of the flooding disaster. According to SBP data, the GDP growth forecast for the current fiscal year has been cut in half to 2%. This decline in overall growth reflects the magnitude of the country’s farm sector’s losses. The policy statement acknowledges the need for food and cotton imports, as well as the loss of export revenue due to crop destruction in rice and cotton. Nonetheless, it hopes that these significant outflows will be offset by lower import bills as a result of lower domestic demand and falling global commodity prices and shipping costs. This appears to be a rather optimistic outlook, especially given that lower commodity prices and “falling global commodity prices and shipping costs” are hard cash in the bank. Oil prices have already begun to rise as a result of OPEC’s decision to reduce output. Europe is about to enter an energy-shortage winter, which could send LNG prices skyrocketing. The agreement to ship Ukrainian grain is holding up for the time being, but who knows when the hardening of attitudes on both sides will put an end to it? Maintaining the current account deficit projection of $3 billion thus appears overly optimistic.
At the upper bound, headline inflation is projected to reach 20%. However, the Monetary Policy Committee makes no mention of how it intends to curb this trend. The choice was obviously between the status quo and a rate hike, with monetary easing out of the question at this point. The MPC may have decided to maintain a halt until more data is available, particularly from flood damage assessments. However, our economy operates within a global paradigm, and the current trend is for higher policy rates, despite recession fears. One hopes they considered the possibility of a US Federal Reserve policy rate hike and its impact on the export sector because the published policy document is silent on the subject. Then there’s the issue of our depleting foreign reserves. It is difficult to see how inflows can be sufficient to offset Pakistan’s foreign exchange needs when the country owes approximately $21 billion in repayments over the current fiscal year. If the government purchases dollars on the open market, the rupee may face renewed pressure. Overall, the new monetary policy appears to be a charter for inaction rather than action—decisions to abstain instead of confessing. The wisdom of this course of action is not immediately apparent, but we will not have to wait long for it to become apparent.