Easing of monetary policy


WEB DESK: Contrary to the expectations that State Bank would not change gear at this point of time, its Monetary Policy Committee (MPC) has opted to ease monetary policy stance albeit only modestly.

In its Monetary Policy Statement (MPS) released on 21st May, 2016, it has been stated clearly that the decision to reduce the policy rate by 25 basis points from 6.0 percent to 5.75 percent was taken after detailed deliberations which implies a thorough discussion of the subject or differences within the MPC about the rate cut in the meeting. Such an inference could also be made by the coverage of MPC which does not provide a clear-cut answer for the change in the direction of monetary policy.

On the positive side, macroeconomic conditions, according to the SBP, continue to improve. Headline CPI inflation would remain below its FY16 annual average target of 6 percent. Real GDP growth would also remain below its target of 5.5 percent but is likely to exceed its FY15 outcome of 4.2 percent. Current account deficit is likely to shrink to the previous year’s level of one percent of GDP and foreign exchange reserves are projected to maintain an upward trajectory.

As credit to private sector increased by Rs 314.7 billion during July-March, FY16 compared to Rs 206.0 billion in the corresponding period last year, GDP growth in FY16 is “expected to provide the needed sustainability in growth trajectory and the basis for further improvement in FY17.” Stability in balance of payments is due to a combination of favourable developments including steady workers’ remittances and low oil prices in the international market. FDI is also projected to increase as the work on projects under the CPEC gains momentum. It goes to the credit of SBP that it was also quite frank and straightforward in enunciating some of the recent developments that did not favour a downward revision in the policy rate.

The most important among them was the likelihood of accentuation of inflationary pressures in the coming months. According to the MPS, “CPI inflation sustained its rising trend for the seventh consecutive month and on YoY basis rose to 4.2 percent in April, 2016 from the low of 1.3 percent in September, 2015. In addition to the seasonal impact of perishable food items and services, this increase owes to further waning of the base effect and second round impact of decline in oil prices.

Similarly, core inflation measures have broadly followed a rising trend in this fiscal year indicating a build-up of underlying inflationary tendencies.” Although average inflation outlook for 2015-16 is subdued, the inflation is likely to attain a higher plateau in FY17. Major sources that will determine this path include a relatively faster pickup in demand compared to supply dynamics, rising global oil prices along with a modest recovery in non-energy commodity prices, the risk of imposition of new taxation measures and an increase in electricity and gas tariffs.

SBP has also foreseen some risks in the external sector of the economy. It says that “with weaknesses in private capital inflows persisting for some time now, uncertainty may arise if there is an adverse change in oil prices or workers’ remittances.” We feel that observations made by the MPC in the MPS can hardly be refuted as they are based on the published data so far and some sound projections. In fact, instead of saying that GDP growth during FY16 is set to exceed the FY15 outcome of 4.2 percent but will be lower than the target of 5.5 percent, the actual data for the current year released by the FBS on 20th May indicating a growth rate of 4.7 percent could have been easily included in the write-up.

So far as data on inflation, current account, foreign exchange reserves, etc., are concerned, these were mostly available for the first 10 months of the current fiscal and could be projected for the remaining part of the year without much effort. The projections for FY17 in the MPS are scanty but are quite in line with the forecasts made by most of the other analysts. However, it is surprising to see that though most of the relevant contents of the MPS call for keeping the policy rate unchanged, MPC opted to decrease the policy rate. The most important factor determining the policy rate is of course the current rate of inflation and its expectations. At no place in the MPS, does the SBP make any bones about the recent rising trend in prices and also seems certain about the accentuation of inflationary pressures in the near future.

It clearly talks about the build-up of underlying inflationary tendencies, a rising trend in core inflation and inflation likely to attain a higher plateau in FY17 and with solid reasons. Rising global oil prices along with modest recovery in non-energy commodity prices, pickup in demand pressures, increase in electricity and gas prices and waning of the base effect could accelerate the rate of inflation further. In the external sector, rise in oil prices and a slowdown in private capital inflows and home remittances could put pressure on the current account which may worsen further by the termination of EFF arrangement with the Fund.

The behaviour of the SBP looks all the more strange when compared with its earlier decisions. In the previous three policy announcements, the SBP kept the policy rate unchanged at 6.0 percent when the inflation was at a lower level on a YoY basis but has decided to reduce it when inflation is moving upwards and likely to persist with this trend. This seems to be at odds with the usual practice in the central banks. The easing of monetary policy would have not mattered much if it had no impact in other areas of the economy. The new stance could ignite inflationary pressures in the economy and have an adverse impact on the lives of the ordinary people. The imposition of regressive tax through inflation is of course inequitable.

This could also depress saving rate further in the economy which is already at a dismally low level. Households would have less incentive to save due to lower returns on their savings offered by banks and National Saving Centres. The investment in speculative activities like in real estate and stocks could increase. Savers would also be tempted more to convert their rupee balances into foreign currencies, depressing the rupee rate further and increasing pressure on the balance of payments position of the country. We don’t know whether the government or the business community had to do something with the decision of reducing the policy rate but these two categories of borrowers could be better off with the present decision.

While the business community could gain by borrowing at a lower rate, the government would be able to reduce its debt servicing cost. The camp favouring a reduction in the policy rate could also argue that the present stance could enhance credit flows to the private sector and help the development process but the private sector credit has already expanded by more than 50 percent during the current year which speaks about the keenness of the private sector to borrow even at the previous rate.

So far as the government is concerned, the real remedy for reducing the debt servicing cost could be found through a reduction in budget deficit and outstanding level of debt. Hopefully, the MPC would be more inclined to give a greater weight to the objective of price stability in future which is considered a key function of any central bank.

Source: Business Recorder