Constituent policy

Inflation and Policy Rate – Editorials

EDITORIAL: Murtaza Syed, Acting Governor of the State Bank of Pakistan, in an interview with local media, acknowledged that the Bank is targeting inflation of 18-20% on average for the current financial year – a projection more realistic than the 11% projected in the budget documents following the implementation of the “preconditions”, which included the increase in the tariffs of public services, gasoline and petroleum products, leading to July 13 in the seventh/ eighth staff-level agreement with the International Monetary Fund (IMF).

It is therefore relevant to note that while on average headline inflation (consumer price index) was around 13% from January to May 2022, it jumped to 21.3% in June and 24.9% in July.

The CPI includes imported goods, particularly petroleum and cooking oil (main imports for Pakistan), whose international prices rose through May to early June as the rupee eroded its value against to the US dollar. In other words, imported inflation was an important component of the calculation of national headline inflation.

The SBP’s ability to deal with headline inflation is limited to tackling disorderly conditions in the currency market as per the agreement with the IMF, defined as extreme volatility in the exchange rate demonstrably evident in that country in June. and July.

The SBP is dealing with this volatility by tightening controls on legitimate dollar releases – a policy move it unfortunately delayed until July. It is however important to note that the rupiah correction is now underway and it is to be hoped that the SBP will revert to the pre-2019 policy decision of tying the discount rate not to headline inflation but to underlying inflation which includes non-inflation. food and non-energy products which can be adjusted by adjustments to key rates.

According to the Pakistan Bureau of Statistics (PBS), core inflation has not been as volatile as headline inflation – from 8.9% in March to 9.1% in April, 9.7% in May , 11.5% in June and 12% in July. Before 2019, the key rate was in the range of plus/minus maximum 2 to 2.5%.

In 2019, before the onslaught of the pandemic, the key rate was 13.75% with headline inflation projected at around 13% by the Fund, with underlying inflation well below around 8%. The key rate is now 15%, ie 3% higher than underlying inflation. If core inflation does not rise in August, the market may well assume that the monetary policy committee due to meet on August 22 will not raise the key rate further, as some market participants fear, speculating that the SBP may have agreed to raise rates further with the Fund.

The IMF is unlikely to release details of the deal with Pakistani authorities online before its board approves the tranche release, expected in the last week of August. A definitive answer will therefore only be available after the MPC meeting. Disturbing information from the market indicates that the proposed rate is close to 17% for government paper and higher for private sector, which reinforces the idea that the MPC could raise the rate further.

However, a caveat is in order: an increase in the discount rate would cripple economic activity, especially large-scale manufacturing, with obvious negative repercussions on unemployment and poverty levels.

We hope that a valuable lesson has been learned by the SBP, namely that linking the policy rate to headline inflation will not control imported inflation, although it will certainly control aggregate demand, thus seriously affecting the quality of life of the poor and vulnerable.

Copyright Business Recorder, 2022