Even though it was made to placate the IMF, THE State Bank’s decision to increase its benchmark policy rate by 100 basis points to a 24-year high of 16 percent after maintaining the status quo in its most recent two monetary policy committee meetings in August and October is a positive step.
Since Ishaq Dar, a supporter of low interest rates and a strong domestic currency, is in charge of the finance ministry, few people expected the bank to increase borrowing costs.
This demonstrates that the ministry and central bank must be yielding after the IMF twice postponed the debate over its ninth programme performance assessment, delaying the delivery of its next loan tranche of more than $1bn due to Pakistan’s refusal to carry out the agreed-upon reforms. According to a statement released following the MPC meeting on Friday, the decision was made to prevent sustained high inflation. The rate rise was also necessary due to ongoing budgetary lapses, notably in the wake of the floods, which are estimated to have cost $30 billion in losses and damages.
The revised inflation prediction for the current fiscal year of 21 percent to 23 percent, due to stronger-than-anticipated inflationary pressures, shows the bank is still behind the curve even if the SBP governor hinted at stopping the rate hike. Despite severely restricting imports, the government has been unable to keep inflation and domestic demand under control as a result of an extraordinary external crisis brought on by declining foreign exchange reserves, a decline in dollar inflows, and a deteriorating fiscal position. Despite the current account narrowing, the rupee has declined.
Negative interest rates are a crucial factor in the rising cost of goods and services as well as the depreciating value of the rupee. The MPC also attributes cost-push inflation to domestic and international supply shocks that are raising prices and costs in the midst of the global economic recession. The increase in borrowing costs should strongly urge the government to alter its irrational fiscal course and rein in its spending as well as target inflation, which is now being driven by negative real interest rates.
However, the inflation that has destroyed millions of homes over the past few years cannot be stopped by monetary tightening alone. As the SBP emphasised in its monetary policy statement, the fiscal authorities must do their part by “maintaining fiscal discipline… to complement monetary tightening, which would collectively assist prevent an entrenchment of inflation and lessen external vulnerabilities.”
Is the finance ministry going to respond to the bank’s advice? It’s likely that the bank’s action will prevent further deterioration in the balance-of-payments position since vital foreign inflows have dried up as a result of IMF review delays.
The SBP would be wise to increase rates more aggressively if fiscal slippages persist in order to make sure the ministry keeps pace. There is currently no alternative choice.
