After the deal

In its latest monetary policy statement the State Bank of Pakistan decided to keep the discount rate unchanged. The policy rate has increased by 12.25 percentage points since April 2022, a first for Pakistan, both in terms of the intensity and frequency of the rate hikes and that it is currently at 22%. Market views were mixed before the MPC issued its statement on Monday, with some expecting a minimal cut of 25 bps, while others were looking at status quo or even an increase. The latter view seemed much likelier to transpire given the IMF’s ‘advice’ to continue increasing interest rates despite inflation receding after hitting a peak of 38% in May, dropping to 29.4% in June, a reduction in prices seen after seven painful months of rising prices. 

The $3 billion IMF lifeline was secured in the nick of time. The country was literally one big-ticket dollar outflow away from default. Tough measures were taken, that included hastily adopted changes to the federal budget just prior to the meeting with IMF officials to seal a deal. It was therefore logical to expect that the government would adhere to the IMF’s instructions with regards to the discount rate, given how much groundwork has already been put in, at the expense of political capital, to secure the crucial deal. A discount rate hike would not have been surprising, a cut would have and maintaining it at the prevalent level was a reasonable middle ground.  

While one can accept the rationalisation for keeping the policy rate where it is at, that inflation had peaked, evidenced by the first drop in months, there is a need to consider events that have taken place simultaneously, whose effects have already been reflected in the month-on-month CPI figure, with prices rising by 3.5% in July.

The basic electricity power tariff increase came first, with an announcement of a rise of Rs 7.5 per unit. While the effect of the basic tariff hike will come into effect in next month’s billing cycle, the Fuel Charges Adjustment (FCA) for May was reflected in July’s bills that significantly increased electricity bills of even the poorest of consumers. Additionally, fuel prices have also been hiked by Rs 20 per liter for both petrol and diesel, with another possible increase expected this month as well. Additionally, with the restrictions on imports mostly removed, a reduction in the current account surplus, leading towards a deficit cannot be ruled out either. The effect is delayed, but it will come and when it does, the rupee will lose value against the greenback, adding more inflationary pressure.

Ishaq Dar is taking a victory lap and painting a deceptively rosy picture of the economy in light of the success with restarting a stalled IMF program. But the conditions that have been set to not revert to the distant yet confrontational relationship with the Fund, must be met, by hook or by crook, all of which will add to the inflation number.

Since there is every possibility of interest rate hikes in the coming months, it is necessary to determine if, at all, monetary tightening addresses rising inflation. In short: it does not. One only needs to look at the effect the LC ban to curb imports had on the current account deficit to understand that as a net importer of goods and services and most importantly, furnace oil to produce energy, discount rate adjustment is a grossly insufficient and inadequate central bank tool to address rising prices.

Perhaps a combination of both works better to address both cost-push inflation, which is most attributable to our high prices problem, and also some demand-pull inflation as well that requires the mopping up of excess liquidity from the market. However, we are at the mercy of the IMF at the moment. The fund will ignore and wait on any incident of macho posturing by the finance minister and get its way. That is exactly what has happened and will continue to happen unless the condition of the economy truly improves in a sustainable manner. That takes long-term macroeconomic reform, something no elected government of the past and present has given any time or thought to.