State Bank justifies hike in interest rate

The Monetary Policy Committee (MPC) of State Bank of Pakistan (SBP) believes that the hike of 150bps on May 23, 2022 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.

It believes the headline inflation is likely to increase temporarily and remain on the higher side in FY23, but expects it to fall to 5% to 7% range in FY24, assuming moderating growth, normalizing global commodity prices and base-effect. NCPI currently is at a 2 year high driven primarily by perishable food items and core inflation. Nevertheless, central banks globally are responding to inflation.

Despite some respite in MoM current account deficit, the Rupee has remained under pressure due to the weak sentiment and a strengthening US dollar. Exports have continued their growth momentum along with robust remittances.

Moreover, growth in imports has been generally driven by crude oil, food items and chemicals including vaccines FY22 TD. Slight drop in volumes recently has been partially offset by higher oil and edible oil imports and higher international prices.

Pakistan is in a comfortable position to meet external financing requirements for FY23. Gross financing needs for Q4FY22 and FY23 stand at US$45 billion. Financing is available to the tune of US$51 billion – large part of which is multilateral loans. Pakistan expects a rollover of US$2.3 billion loan from China. 

Discussions with the International Monetary Fund (IMF) are progressing well in Doha. However, delays might occur given that the budget for FY23 is also part of the ongoing discussions. The IMF requires ‘political assurances’ which may not preclude a caretaker setup from negotiating the program as well. The IMF has negotiated with caretaker setups in other countries in past.

The incumbent coalition government headed by Shehbaz Sharif is keen on continuing with the low-cost housing schemes. However, given the need for fiscal consolidation lending targets assigned to commercial banks for lending to private developers etc. might be reviewed.

The MPC also emphasized the need for strong and equitable fiscal consolidation to complement monetary policy measures.

 

 

State Bank of Pakistan raises policy rate by 150bps to 13.75 percent

In its meeting on May 23, 2022, the Monetary Policy Committee (MPC) decided to raise the policy rate by 150 basis points to 13.75%. 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.

Since the last MPC meeting, provisional estimates suggest that growth in FY22 has been much stronger than expected. Meanwhile, external pressures remain elevated and the inflation outlook has deteriorated due to both home-grown and international factors.

Domestically, an expansionary fiscal stance this year, exacerbated by the recent energy subsidy package, has fueled demand and lingering policy uncertainty has compounded pressures on the exchange rate. Globally, inflation has intensified due to the Russia-Ukraine conflict and renewed supply disruptions caused by the new Covid wave in China.

As a result, almost all central banks across the world are suddenly confronting multi-year high inflation and a challenging outlook.

After contracting by 0.9% in FY20 in the wake of Covid, the economy has rebounded much more strongly than anticipated, growing by 5.7% last year and accelerating to 5.97% this year, as per provisional estimates. At 13.4%YoY, headline inflation unexpectedly rose to a two-year high in April and has now been in double digits for six consecutive months.

Inflation momentum was also elevated, at 1.6%MoM, and core inflation rose further to 10.9% and 9.1% in rural and urban areas, respectively. On the external front, notwithstanding some encouraging moderation in the current account deficit during April, the Rupee depreciated further due both to domestic uncertainty as well as recent strengthening of the US dollar in international markets following tightening by the Federal Reserve.

The MPC’s baseline outlook assumes continued engagement with the IMF, as well as reversal of fuel and electricity subsidies together with normalization of the petroleum development levy (PDL) and GST taxes on fuel during FY23. Under these assumptions, headline inflation is likely to increase temporarily and may remain elevated throughout the next fiscal year. Thereafter, it is expected to fall to the 5 to 7% target range by the end of FY24, driven by fiscal consolidation, moderating growth, normalization of global commodity prices, and beneficial base effects.

Considering the balance of risks around this baseline, the MPC felt it was important to take effective action to anchor inflation expectations and maintain external stability. In addition to today’s policy rate increase, the interest rates on EFS and LTFF loans are also being raised.

Going forward, to strengthen monetary policy transmission, these rates will be linked to the policy rate and will adjust automatically, while continuing to remain below the policy rate in order to incentivize exports. At the same time, the MPC emphasized the urgency of strong and equitable fiscal consolidation to complement today’s monetary tightening actions. This would help alleviate pressures on inflation, market rates and the external account.

Real sector

Unlike most emerging markets, Pakistan experienced a relatively mild contraction after the Covid shock in 2020, followed by a sustained and vigorous rebound. As a result, output is now above its pre-pandemic trend, such that tightening of macroeconomic policies that is necessitated by the presently elevated pressures on inflation and the current account is also warranted from the perspective of demand management. Most demand indicators have remained strong since the last MPC—including sales of POL and automobiles, electricity generation, and sales tax on services—and growth in LSM accelerated in March. Both consumer and business confidence have also ticked up. With the output gap now positive, the economy would benefit from some cooling. On the back of monetary tightening and assumed fiscal consolidation, growth is expected to moderate to 3.5% to 4.5% in FY23.

External sector

The current account deficit continues to moderate. In April, it fell to US$623 million, less than half the average for the current fiscal year, on the back of lower imports and record remittances. Based on PBS data, the trade deficit shrank by 24% relative to its peak last November. These developments are in line with SBP’s projected current account deficit of around 4% of GDP this year.

Next year, the current account deficit is projected to narrow to around 3% of GDP as import growth continues to slow with moderating demand and the recent measures taken by the government to curtail non-essential imports, while exports and remittances remain resilient.

This narrowing of the current account deficit together with continued IMF support will ensure that Pakistan’s external financing needs during FY23 are more than fully met, with an almost equal share coming from rollovers by bilateral official creditors, new lending from multilateral creditors, and a combination of bond issuances, FDI and portfolio inflows.

As a result, excessive pressure on the Rupee should attenuate and SBP’s FX reserves should resume their previous upward trajectory during the course of the next fiscal year.

Fiscal sector

Instead of the budgeted consolidation, the fiscal stance in FY22 is now expected to be expansionary. At 0.7% of GDP, the primary deficit during the first three quarters of the year compares unfavorably with the primary surplus of 0.8 percent of GDP during the same period last year. This slippage was driven by a sharp rise in non-interest expenditures, led by higher subsidies, grants and provincial development expenditures.

The resulting demand pressures have coincided with the sharp rise in costs from the surge in global commodity prices, exacerbating inflationary pressures and the import bill. Timely action is needed to restore fiscal prudence, while providing adequate and targeted social protection to the most vulnerable. Such prudence enabled Pakistan’s public debt to decline from 75% of GDP in FY19 to 71% in 2021 despite the Covid shock, in sharp contrast to the average increase of around 10% of GDP across emerging markets over the same period.

Monetary and inflation outlook

In nominal terms, private sector credit growth remained robust through April, reflecting strong economic activity and higher input prices which have enhanced working capital requirements of firms. Since the last MPC meeting, secondary market yields, benchmark rates and cut-off rates in the government’s auctions have risen, particularly at the short end. The MPC noted that the market rates should be aligned with the policy rate and in case of any misalignment after today’s policy decision, SBP would take appropriate action.

Headline inflation rose from 12.7%YoY in March to 13.4% in April, driven by perishable food items and core inflation. The rise in core inflation reflects strong domestic demand and second-round effects of supply shocks.

At the same time, measures of long-term inflation expectations have also ticked up. As electricity and fuel subsidies are reversed, inflation is likely to rise temporarily and may remain elevated through FY23 before declining sharply during FY24. This baseline outlook is subject to risks from the path of global commodity prices and the domestic fiscal policy stance. The MPC will continue to carefully monitor developments affecting medium-term prospects for inflation, financial stability, and growth.

 

Further hike in interest rate by the central bank could prove suicidal for Pakistan

State Bank of Pakistan (SBP) is scheduled to announce a key monetary policy decision on May 23, 2022. The analysts and market participants keenly await SBP policy direction given Pakistan's economic uncertainty.

The consensus is growing in Pakistan that further hike in interest could prove suicidal for the country. The debt servicing by the Government of Pakistan (GoP) has become unsustainable. On top of that any hike in cost of doing business will dampen prospects of boosting exports. Let everyone remember that Pakistan suffers from cost-pushed inflation.

Since the last Monetary Policy announcement on April 07, 2022, secondary market rates including T-Bill/Kibor rates have gone up by around 200bps due to uncertainty about continuation of IMF program and removal of subsidies on petrol and diesel. 

It will also be interesting to see SBP’s stance as this will be the first monetary policy statement after the recent change in the government and appointment of Dr. Murtaza Syed as acting Governor of the central bank.

The most recent T-Bill auction tell a different story, the cut off yields declined for the first time after almost a year, down by 5nbs to 29bps with 3/6/12 months T-Bill yields clocking in at 14.49%, 14.70%, and 14.75% respectively.

For further clues let us go through some details of a survey conducted by Pakistan’s leading brokerage house, Topline Securities. Questions were asked on interest rate, inflation, currency, GDP growth and current account deficit outlook.

As per the survey results, around 54% of the participants expects an increase of 100bps, 14% of the participants anticipate an increase of 150bps and 11% expect an increase of 200bps or more. As against this 13% participants expect increase of 50bps and 9% expect no change.

Participants remained divided on policy rate expectations by end of FY23. 27% of the participants expect policy rate to close at 13% by end of next financial year. 41% of the participants expect it to above 13% while 32% anticipate it to be below 13%.

In terms of currency outlook, 39% of the participants expect PKR/USD to close above 205 by the end of next financial year. 9% believe it will remain in the range of 200-205 by FY23 end. 23% expect it to close in between 195 to 200 while the remaining anticipates it to be below Rs195.

27% of the participants are expecting inflation of 13-14% in FY23, 16% expect it to be between 14 to 15 percent, 4% anticipate it to be above 15%. The remainder of the respondents is eyeing an inflation of lower than 13% in FY23.

In terms of GDP growth, 7% of the participants think that GDP growth will be below 3% and 32% of them expects it to be between 3-3.5%, whereas 23% of the participants project it to be 3.5%-4.0%. The remainder of them anticipates it to be above 4%. 

Participants remained divided on the expectations of current account deficit forecast for FY23 as 46% participants expect current account deficit to be in the range of US$12 billion to US$15 billion while 18% participants anticipate it to above US$15 billion. The remainder of them expects it to be below US$12 billion.  

Pakistan is currently facing tough economic times as depleting foreign exchange reserves, rising fiscal deficit amid huge petrol/diesel subsidy and indecisiveness by the new government on key economic measures is exacerbating economic issues.

It will key for government to take the required reform steps including removal of subsidy on petrol/diesel, measures to curb imports and improve tax collection. This will pave way for the resumption of IMF program which currently remain stalled and will result in dollar flows that could ease pressure on currency and foreign exchange reserves going forward.

Given concerns highlighted above along with rising inflation and weakening currency, analysts anticipate SBP to raise the policy rate by 100bps.

 

Pakistan: Coalition on the path to collision

Pakistanis are getting jittery because of the ‘politically loaded’ statements from the ruling coalition as well as the opposition headed by Imran Khan. 

PTI Chairman on Sunday announced that his party's long march towards Islamabad for the country's "battle for real freedom" would begin on May 25, 2022.

He said the main demands for the march to the capital were the immediate dissolution of the National Assembly and announcement of a date for the next general election.

Khan wants to charge the mob by saying, "I want people from all walks of life to come because this is Jihad, and not politics. I've decided and told all my team that we have to be ready to sacrifice our lives."

Imran indicated that the march would convert into a sit-in and continue until his demands are accepted. "We will never under any situation accept them. No matter how long we have to remain in Islamabad we will remain there."

I am surprised at the logic and narrative of Khan. If he wants fresh elections, he should ask his party members (MNAs) to resign and the coalition will have no option but to go for fresh election.

I have a feeling that Khan fears that in case his party members resign the stage would be set for the creation of an interim government and elections would be deferred till completion of the electoral reforms.

PML-N-led coalition government appears unwilling to take the blame for any unpopular decisions it may have to take to fix the economy. It wants guaranteed backing of the powerful military establishment to help it see through the remaining period of its tenure till August 2023.

The coalition believes it can handle the PTI march if other things are sorted out with the establishment. Interior Minister Rana Sanaullah has expressed his wish to arrest Khan provided he gets the ‘go-ahead’, as he thinks even one day in prison would make the ousted premier forget politics.

It is highly regrettable that neither Khan nor Sharif understands the gravity of situation. Pakistan has to satisfy the International Monetary Fund (IMF) and seek the ‘fitness certificate’ to pave way for the immediate release of US$1 billion. This would be the preamble for release of funds by other multilateral financial institutions as well as friendly countries.

It is therefore suggested that the ruling junta should show some endurance and Khan should also support the incumbent government in the preparation and approval of the federal budget for the next financial, likely to be announced on June 10, 2022.

In my opinion even the most contentious issues should be discussed and resolved in the parliament and should not be taken to the streets. At present the top national priority is approval of the federal budget.  It is better that Khan and Sharif develop working relations at the earliest.

Pakistan: Shehbaz Sharif caught between a rock and a hard place

Reportedly, the PML-N-led coalition government appears unwilling to take the blame for any unpopular decisions it may have to take to fix the economy. It wants guaranteed backing of the powerful military establishment to help it see through the remaining period of its tenure till August 2023.

The coalition, despite pressure from within its ranks to clear the air about the possibility of early polls or taking unpopular decisions, is looking to the powers that can make its tenure peaceful. With each passing day, the government’s indecisiveness is taking a toll on the already sinking economy, as well as governance.

The current rulers appear reluctant to take up a ‘perceived offer’ from the establishment to enter into a bailout deal with the IMF, present the federal budget next month and immediately announce the date for polls.

This is a sticking point at the moment, the coalition parties are of the view that taking difficult decisions on the economic front for a short term will cost them dearly if elections are held early.

It appears that all allied parties have agreed on completion of the 15-month term. The problem is that if the IMF agrees, the economy can be revived. But raising petroleum prices does not seem acceptable. PML-N wants the support from ‘all sides’ to steer the country out of the crises, without being blamed for taking unpopular decisions.

Shehbaz Sharif, who has a reputation of being an efficient administrator, could not assert himself. His role seems to have been reduced to an ‘interlocutor’ among his elder brother Nawaz Sharif, the establishment and the coalition partners — PPP and JUI-F in particular.

Sharif looked very enthusiastic during the first couple of weeks after assuming charge, now seems to have lost the steam and is finding it hard to negotiate the difficult position his government finds itself in today.

The dire situation facilitates the ‘architect’ of the ruling coalition, PPP co-chairman Asif Ali Zardari, to once again reach out to the heads of all allied parties to come up with a fresh strategy. On Saturday, he called on Shehbaz Sharif and discussed the challenges in detail.

The meeting also assumed importance as Zardari flew in to Lahore from Islamabad in the backdrop of the denial of relief to Prime Minister Shehbaz from a special court in a money laundering case that declined to confirm his bail.

A brief statement issued after the over 90-minute meeting said, “The meeting discussed the current situation, especially the economy, in the country. The coalition partners expressed their complete confidence in the leadership of the premier and praised the incumbent government for its steps for the welfare of the people.”

The fast-changing political scenario, followed by ousted premier Imran Khan’s pressure through massive rallies and an impending long march on the capital, has forced the main players of the coalition to review the strategy they formed before toppling the PTI government early last month.

The coalition believes it can handle the PTI march if other things are sorted out with the establishment. Interior Minister Sanaullah has expressed his wish to arrest Khan provided he gets the ‘go-ahead’, as he thinks even one day in prison would make the ousted premier forget politics.

PML-N Vice President Maryam Safdar also voiced her father’s views on it, saying “Nawaz Sharif is ready to say goodbye to the government, but not pass on the economic burden to the people of Pakistan, as there is no point in carrying the weight of the blunders of Imran Khan. It’s better to go to the masses to seek a fresh mandate.”

The coalition government is likely to take a decision about whether to stay in government or go for fresh polls after its final ‘backdoor talks’ with the establishment next week. The perception is, “If things don’t work out, the coalition will immediately rush for electoral and accountability reforms and to announce the date for elections.

Will Pakistan default? May be yes, may be not

Lately, the question is getting louder, Will Pakistan default? The critics are distinctly divided into two groups, one saying may be and other saying may be not. Both the groups have their own premises and none can be termed right or wrong.

I am of the opinion that Pakistan has never defaulted in the past and it will never be allowed to default. As in the past, the country will be bailed out, on the eleventh hour. The IMF and all other multilateral institutions can’t afford an atomic power to commit default.   

I am of the opinion that at present Pakistan does not appear to be a circumstantial defaulter but indecisiveness of the incumbent coalition government, headed by Shehbaz Sharif is making it difficult for the lender of last resort, International Monetary Fund (IMF) to conclude the deal.

Without mincing my words I will say’, “Shehbaz Sharif does not understand gravity of the situation, he acting stubborn and many of his decisions can be termed self destructive”. My premise is based on his consistent refusal to increase electricity and gas tariffs and petroleum price.

I have spoken to some business leaders and even the common man on street says, “Pakistan has no option but to arrive at consensus with the IMF and get the next tranche released”. Saudi Arabia is willing to give US$3 billion, subject to release of the tranche by the IMF. Ironically, Shehbaz and his economic advisory team have failed in understanding this clue.

I tend to support the group which says, “Pakistan has the capacity to avert an eminent default”. The current balance of payment crisis is because of huge imports and paltry exports. The gap is being bridged by US$2.5 billion remittances received every month. Many of the critics fail to understand this blessing. Please recall “IMF has promised to give US$2 billion over the next two years, but overseas Pakistanis are sending US$2.5 billion per month”.

The next step is to curtail import by banning or imposing quantitative restrictions. The incumbent government has decided to curtail import which is praise worthy decision. However, it is committing a horrendous by opting for load shedding of electricity to curtail oil import bill. Outages in the industrial areas are affecting output, raising cost of doing business and eroding competitiveness of the Pakistani exporters.

One of the factors responsible for higher import of food items is rampant smuggling of these products to the neighboring countries. This smuggling can be stopped simply by allowing export of these items to Afghanistan, India and Iran. Both Afghanistan and Iran, also suffering from acute shortage of foreign exchange, are keen in entering into barter trade and/or trade in Pakistani currency.

Please allow me to say that if Shehbaz continue to live under the shadow of Nawaz Sharif and Ishaq Dar, he will sink deeper into the mess. He must listen to his coalition partners and make some difficult decisions. However, he has to get rid of his idiosyncrasies and behave like a real statesman.

Is Bangladesh heading toward a Sri Lanka like crisis?

According to a report in South Asia Journal, like Colombo, Dhaka has also taken on massive foreign loans to embark on what critics call ‘white elephant’ projects. The economic turmoil in Sri Lanka should serve as a cautionary tale for Bangladesh, say experts.

Soaring prices of essential items are bringing enormous pain to economically weaker sections of Bangladeshi society. Sri Lanka has been mired in economic turmoil over the past few months, with the country battling severe shortages of essential items and running out of petrol, medicines and foreign reserves amid an acute balance of payments crisis.

The resulting public fury targeting the government triggered mass street protests and political upheaval, forcing the resignation of Prime Minister Mahinda Rajapaksa and his Cabinet, and the appointment of a new Prime Minister.

Many in Bangladesh fear that their country could face a similar situation, given the rising trade deficit and foreign debt burden.

Bangladesh imported goods worth US$61.52 billion during the first nine months of the 2021-22 fiscal year, a rise of 43.9% as compared to the same period last year.

However, exports rose at a slower pace of 32.9% while remittances from Bangladeshis living abroad — a key source of foreign exchange — dropped about 20% in the first four months of 2022 from the year before, to US$7 billion.

Muinul Islam, a Bangladeshi economist and former professor at Chittagong University, fears that the trade deficit could grow in the coming years as imports are increasing at a faster pace than exports.

“Our imports are set to reach US$85 billion by this year, while exports won’t be more than US$50 billion. And, the trade deficit of US$35 billion can’t be bridged by remittances alone,” Islam told adding: “We will have to live with around a US$10 billion shortfall this year.”

The expert also pointed out that Bangladesh’s foreign exchange reserves have fallen from US$48 billion to US$42 billion over the past eight months. He is worried that they may drop further in the coming months, likely down another $4 billion.

“If the trend of more imports against exports continues and we fail to minimize the gap with the remittances, our foreign reserves will go down to a dangerous level in the next three to four years,” he stressed, underlining that this would lead to a significant devaluation of the nation’s currency against the US dollar.

Bangladesh, like Sri Lanka, has also taken on foreign loans in recent years to fund what critics call “white elephant” projects, which are expensive but totally unprofitable.

These unnecessary projects could cause trouble when the time comes to repay the debts, Islam said.

“We have taken a loan of US$12 billion from Russia for a nuclear power plant which has a production capacity of just 2,400 megawatts. We can repay the debt in 20 years but the installments will be US$565 million per year from 2025,” he pointed out. “It’s the worst kind of a white elephant project.”

In total, the country will likely have to repay US$4 billion per year from 2024, as installments for foreign loans, Islam estimated.

“I fear Bangladesh won’t be able to repay those loans at that time because of the shortage of income from the mega projects,” he stressed.

Prime Minister Sheikh Hasina’s government has taken several steps to slash spending and save foreign currency reserves.

Nazneen Ahmed, Bangladesh economist at the United Nations Development Program (UNDP) office in Dhaka, said that the government has to make sure the projects are completed without additional cost and delay.

“We have to finish the mega projects carefully. There is no room for negligence and corruption. Those projects should neither be delayed nor the existing budget be increased,” she said, adding, “If we can finish them on time, only then will we be able to repay the loans we have taken for them.”

Adding to the problems of debt and deficit is the surge in prices of essential items.

The Russia-Ukraine war, which began at the end of February, has compounded the inflationary pressure.

Bangladesh has been particularly vulnerable as the country imports significant amounts of goods like cooking oil, wheat and other food items, as well as fuel.

Ahmed said that poor people are suffering the most because of the skyrocketing prices of these items.

“The government has to offer commodity goods subsidized to the poor people. Additional financial support should also be provided to them under a social security system,” she noted.

But the expert remains optimistic about the South Asian nation’s prospects, saying that the current economic indicators could improve as the global economy recovers from the COVID pandemic-induced downturn.

“We have been observing inflation worldwide during the COVID recovery phase. The Ukraine war has added more uncertainty to it. And the economic crisis in Sri Lanka has also created fear among us,” she told adding, “Still, if nothing big happens within the next few years, the global economy will recover again.”

Prime Minister Sheikh Hasina’s government has taken several steps to slash spending and save foreign currency reserves.

It has decided to suspend foreign trips of officials and postponed some less important projects that require imports from other countries.

Hasina has also urged citizens to do their bit, by practicing austerity and being careful about spending decisions.

“The Prime Minister earlier gave some directives to the government officials on practicing austerity. She called upon the private sector and the people to be economical,” Bangladesh’s Planning Minister M A Mannan said during a press conference in Dhaka.

Islam said that the government needs to be extremely careful with economic management, given the widespread suffering on account of soaring price rises, which could aggravate the already high political tensions in the Muslim-majority country.

“Bangladesh’s last election was not good. It was a fraudulent one. Another national election is due in the next two years. So the political situation will remain tense anyway. The economic uncertainty could fuel it even more.”

While the experts don’t see any imminent economic crisis, they believe that good governance and financial management are needed to ensure Bangladesh doesn’t end up facing a situation that Sri Lanka now finds itself in.