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Announced monetary policy on 20th May 2019 indicating worst economic situation in coming days


Muhammad Arif

As a first step SBP monetary policy was a test for new Governor of SBP Dr Reza Baqir. The Policy was announced on 20th May with an increase of 150 BP reaching to 12.25% effective from 21st May 2019.

The bank announced that changes occurred due to certain factors i.e. possibility of changes in utility tariffs, the higher level of fiscal deficit, the recent decline in foreign reserves, and the rising inflation — merit more policy decisions.

Here we may refer the Phillips curve which states that inflation and unemployment have an inverse relationship. Higher inflation is associated with lower unemployment and vice versa. However the Phillips curve was a concept used to guide macroeconomic policy in the 20th century, but was called into question by the stagflation (rise of inflation and unemployment simultaneously) of the 1970’s. Pakistan at the moment is standing at the juncture of stagflation.

The reasons for increase states that fist of all the government of Pakistan have reached a staff-level agreement with the International Monetary Fund for 39-month long Extended Fund Facility of around US$ 6.0 billion. The program is designed to restore macroeconomic stability and support sustainable economic growth, and is expected to unlock considerable additional external financing. Second, trends in government borrowing reflect a widening fiscal deficit during the first nine months of FY19 when compared to the same period in FY18. In addition, a greater reliance on central bank financing of the deficit has acted to dilute the impact of previous monetary tightening. Finally, since the last MPC, the exchange rate has depreciated by 5.93 percent to PKR 149.65 per USD, at the close of 20th May 2019, reflecting a combination of underlying macroeconomic factors and market sentiment considerations.

SBP’s estimates that economic growth is expected to slow in FY19 but rise modestly in FY20. Expected to go down to below 3% of GDP in comparison to above 5% of GDP in 2017 and 2018. More than two-thirds of real GDP growth in FY19 is expected to come from services. Going forward, some gradual recovery in economic activity is expected on the back of improved market sentiment in the context of the IMF supported program, a rebound in the agriculture sector and government incentives for export oriented industries.

The current account deficit has narrowed to US$ 9.6 billion in Jul-Mar FY19 as compared to a deficit of US$ 13.6 billion during the same period last year, a fall of 29 percent. The reduction is mainly driven by import compression and a healthy growth in workers’ remittances. This impact was partially offset by higher international oil prices.

But despite the improvement in the current account and a noticeable increase in official bilateral inflows, the financing of the current account deficit still remains challenging. Consequently, reserves declined to US$ 8.8 billion as of 10th May 2019 from US$ 10.5 billion at end-March 2019. The exchange rate also came under pressure in the last few days. In SBP’s view, the recent movement in the exchange rate reflects the continuing resolution of accumulated imbalances of the past and some role of supply and demand factors.

As regards fiscal deficit it remained considerably higher during Jul-Mar FY19 as compared to the same period last year due to a shortfall in revenue collection, higher than budgeted interest payments. It may cross Rs 2 trillion at the end of FY 2019 equal to 7-8% of GDP.

Headline CPI inflation is expected to be in the Range of 6.5-7.5 percent in FY19 or may go above 10% in the coming months and it is anticipated to be looking higher even in FY20. This inflation outlook is subject to a number of upside risks from an expected rationalization of taxes in the upcoming budget, potential adjustments in electricity and gas tariffs, and volatility in international oil prices. The inflation outlook suggests a fall in real interest rates on a forward-looking basis.

Hence at the moment monetary policy announced cannot do much worst and for that we have to wait for the coming budget. Only deep structural reforms are required to improve productivity and competitiveness of export-oriented sectors and to improve the trade balance but from current government the expectations are not looking positive and for coming improvement after some period we have to wait till thousands of low trodden people may perish due to hunger with no health facilities.

However outlook for emerging Asia remains favorable (up 6.3% in both years), with China’s growth projected to slow gradually from 6.3% in 2019 toward sustainable levels (6.1% in 2020). But Latin America, the Middle East, North Africa, part of sub-Saharan Africa and the Pakistan are showing a mixed midterm with downward outlook, partly clouded by subdued commodity prices civil strife or conflict or wrong policies of the governments.

Currently Pakistan’s ability to attract foreign direct and domestic investment has fallen dramatically during the past decade. Several factors have caused the drop—with the threat of terrorism heading the list, the country’s long-running energy shortage with ongoing natural gas disputes.
To attract foreign investment wide choices of projects for FDI investors with stable monetary policy and to repatriate Investment gains and dividends easily are very much required.

Finally as we know that being sufferer of stagflation and keeping numbers of inflation below 10 as of May 2019, the decision to increase discount rate by 150 bp looks quite hawkish. Hence before budget it was far better to hold discount rate at 10.75% for the time being.


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