The 650bn rupee question: will monetary tightening bridge the divergence between monetary and fiscal policy?

Earlier this week, the State Bank of Pakistan announced a 150 bps policy rate hike. Conventional wisdom would say that the logic behind a policy rate hike is inflation. Higher interest rates make loans more expensive for both businesses and consumers, and everyone ends up spending more on interest payments

But more even than getting the government to increase interest payments, the goal of the SBP in increasing the policy rate seems to be dissuading the government from borrowing more. In essence, the move is a babysitting measure meant to discourage the government from being fiscally irresponsible. The official explanation given behind the hike was that “this action, together with much needed fiscal consolidation, should help moderate demand to a more sustainable pace while keeping inflation expectations anchored and containing risks to external stability.”

The SBP’s call for “timely action” to “restore fiscal prudence, while providing adequate and targeted social protection to the most vulnerable” also indicates that a key element of the statement released by the central bank is the divergence between the monetary and fiscal policy. This is the first time in the recent few years where the SBP is calling for fiscal prudence. This hints at how things may have gotten out of hand.