Dr. Muhammad Shahid
Fiscal year 2021-22 is about to end and the general public, economic managers and even State
Bank of Pakistan are beginning to lose faith in the forecasts they have made. There is also a huge
pressure on the foreign exchange reserves due to the worsening trade deficit. Our import bill
reached to 58.7 billion dollars during the first nine months of the current fiscal year. On the other
hand, our exports just reached 23.3 billion dollars during the same period thus registering a
colossal trade deficit of 35.4 billion dollars. The domestic political chaos, rising risks to the IMF
program and the elevated crude oil prices in the international market further added fuel to the fire
and led to speculation and uncertainty. This brought a huge pressure on the foreign exchange
reserves and caused the rupee to devalue to the new low of 190.50 against the dollar. Rupee
gained some strength after the Supreme Court’s verdict.
SBP said the timely demand-moderating measures and strong exports and remittances saw the
February current account deficit shrink to 0.5 billion dollar, its lowest level this fiscal year. The
political instability created by the no confidence move and the resulting uncertainty contributed
to a 5 percent depreciation in rupee and a sharp rise in domestic secondary market yields as well
as Pakistan’s Eurobond yields. SBP’s reserves are on declining trend and it decreased by 728
million dollars to 11.319 billion dollars, largely on debt repayment. There is also some news of
the government payment pertaining to settlement of an arbitration award related to a mining
project.
We cannot turn a blind eye to the sharp erosion in our foreign exchange reserves. The passive
approach of not using the precious reserves by SBP to stabilize the rupee is not a surprise after
awarding autonomy to SBP. We expect further deterioration in the outlook for inflation. We also
expect an increase in risks to external stability in the presence of such a huge trade and budget
deficits. These risks were further heightened by the Russia-Ukraine conflict and domestic
political chaos. The political turmoil would make it difficult to convince IMF to disburse the
much-needed loan tranche. In this situation, the strong and proactive policy response by SBP to
address inflation and arrest the declining rupee is understandable.
During the past few months, inflation rate has risen sharply. Consumer Price Index (CPI) on
Year on Year basis for the month of March ended with 12.7 percent. This higher inflation has
weakened consumer spending power because there is significantly decline in the value of money.
The current spell of inflation has several reasons. The emergence of Covid-19 in 2020, supply
chain disruptions, surging commodity prices during the economic rebound phase, unprecedented
policy support in the form of expansionary fiscal policy, stimulus and bail-out packages, easy
monetary policy with a substantial cut in the policy rates. The recent attack of Russia on Ukraine
further triggered the surge in global oil and grain prices.
As an economist, I am worried that SBP raised interest rates too quickly and too much which
will stall the economy. I do believe that it is likely to create additional upward pressure on
inflation and weigh on economic activity. Cost of borrowing will increase and businesses will
stop borrow to invest. This could lead to higher unemployment if businesses stop hiring or even
lay off workers. If policymakers really overshoot on rate hikes, it could push the economy into a
recession, halting and reversing the progress it has made so far.
Inflation in Pakistan is mainly caused by external factors. The contractionary monetary policy
stance of the state bank cannot unblock ports. Our monetary policy cannot play any role to
resume supply chains and it will not bring the pandemic to an end. People in the finance
ministery, monetary managers and most economists have said that the factors causing inflation to
rise would be temporary. They were also of the view that factors responsible for growth to slow
are also transitory and will not stay for long. Outlook reports of the different leading
organizations also indicated that supply-chain bottlenecks would subside. Energy prices would
return to normal. Workers staying out of the labor force would return to work in the process of
returning to normalcy.
Our economy has made an impressive recovery from the lows of the pandemic. Thanks in part to
the generous fiscal stimulus by the government of Pakistan and a massive cuts in policy rates by
State Bank of Pakistan. We also accept the fact that SBP should work actively by not allowing
this higher inflation to become entrenched. Of course, ideally SBP would like to raise the policy
rates gradually so that the economy slows just enough to bring down prices without creating too
much additional unemployment. SBP has to carefully walk that tightrope. The consequences for
growth, stability, employment, poverty and inequality are likely to be terrible. Sinclair once said
that treating inflation in the economy is like treating cancer with chemotherapy. You have to kill
parts of the economy to slow things down. It’s not a pleasant treatment.
The dilemma facing policymakers is acute. They are not ok with inflation, slow growth,
unemployment, growing trade deficit, falling reserves and budget deficit. Technically speaking,
the answer to inflation is to ignore it. We know that the current wave of inflation is caused by
supply disruptions. Prices will subside once the dust is settled down at the global level.
The author has a PhD degree in Economics from PIDE and Working as Research Officer
at the Economic Advisory Wing.
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