The market is expecting status quo to be maintained in tomorrow’s (July 25, 2015) Monetary Policy review. All nineteen research houses of brokerage firms, asset management companies and commercial banks contacted by BR Research are of the view that the central bank will not change the policy rate in the upcoming review on Saturday. Will SBPs decision match the expectations?
A review of recent MPS decisions shows that since November 2014, the central bank has been more aggressive in easing its policy stance than the expectations of the market. In November, half of all surveyed analyst expected status quo but SBP went for a 50 bps cut.
Similarly, in January, the prevalent expectation was a cut of 50 bps but the central bank surprised everyone with 100 bps of easing. In March, the outcome matched expectations (50bps cut) and in May once again the central bank was more lenient in its easing stance; beating market expectation to not only go for a cut of 100 bps but also narrowing the interest corridor to make the effective easing 150 bps.
The policy rate today at seven percent is 44 years’ low and the newly introduced target rate is 6.5 percent – benchmark for interbank rates. Is the question that does the economy have further room for easing? The efficacy of monetary easing in driving growth also merits analysis.
One of the most important indicators used by both producers and consumers in budgeting and expansion is currency value; Rupee-Dollar parity. According to a recent SBP staff note, a survey of 1,189 firms in manufacturing and services sector showed that the majority of firms consider currency depreciation as the most important factor in setting prices. The other key factors are the cost of raw materials, the overall cost of doing business and energy prices.
The behavior is in contradiction to a conventional economic theory which would list labor cost, cost of capital and labor productivity as dominant factors to set prices. The departure from conventional theory limits the efficacy of interest rates tool in not only setting prices but also in boosting economic growth. The factors that can improve overall cost of doing business include law and order situation, energy provisioning and consistent economic policies; and all these have nothing to do with monetary policy.
Apparently, the philosophy of the Finance Minister is to provide impetus to the economy through pricing intensives – idea is to manage currency artificially to anchor inflation and once the inflationary expectations are low (prevalent case), lower the interest rates to boost economic activities. The first leg of the theory worked better than his expectations as depressed commodity prices went a long way to take inflation down to multi-year low.
The question is what will it translate into boosting economic growth? Without it, the policy of having managed exchange rate can be counterproductive as low inflation will boost consumption and without any production increase, the pressure on current account will build.
Sooner or later, the Balance of Payments troubles will resurface and that could lead to a sharp depreciation of the local currency followed by higher inflation and tightening monetary stance.
History suggests sudden shock is detrimental and a better way to avert crisis is to let the currency float at its real value. But Dar is betting on reaping fruits from managed currency.
So far, the demand factors are taking a back seat and supply-side elements are driving prices. Inflation is down primarily due to cost push factors – low oil prices and stable currency while credit to the private sector remains muted to negate any benefit to economic growth.
Macroeconomic stabilization has been achieved thanks to low inflation, building reserves and lower fiscal deficit; but the growth is largely missing. To boost it, the government is aggressively easing monetary policy but so far this has not worked.
The monetary aggregates picked up in the last quarter taking the full-year money supply growth to 13.2 percent. CPI recorded at 4.5 percent and real GDP grew by 4.2 percent. Where is the rest of 4.5 percent? Evaporated in thin air? The SBP staff paper note by Mushtaq Khan says that Pakistan has a substantial undocumented economy and accumulation of wealth is taking place in real estate, jewelry and/or foreign currency cash holding.
Now with stable rupee against USD and its appreciation against many other major currencies is limiting the scope of foreign currency cash holding. Gold prices are on a southward journey as well to discourage parking of savings. The most lucrative avenue left is to park the excess money in real estate market and probably four percent of money growth in FY15 is routed to the property market.
The untracked money is not a small amount; it’s Rs450 billion in FY15, and being diverted to real estate market, it will only boost property prices which are not captured in CPI as it is gross undervaluation. Is this what Dar envisages? If not, please revisit the policy of keeping artificially stable exchange rate and excessive monetary easing.
Yet there is some hope. Overall sentiments are better; economic and security perception of Pakistan is improving in international media with better outlook by rating agencies. All that it needs is to translate into expansions of existing businesses and a flurry of new ventures both by domestic and foreign investors. Failure to do so can bring another crisis like 2008 in a couple of years.
Coming back to tomorrows policy review, the circles close to policymakers are eying a cut of 50 bps which is against the expectations of the broader market.
The current account after showing a surplus in the third quarter is back in deficit in the fourth quarter to take full year CAD to 0.8 percent of GDP – barring CSF flows it was 1.4 percent of GDP. Now with expansion plans, there will be more machinery import and CSF money is hard to come by in FY16 – so the need is to keep a close eye on the current account deficit.
On the capital front, only debt flows or one-off disinvestment of blue-chip companies have raised foreign exchange reserves to $18.6 billion. But the debt repayments will start in FY17 by which time privatization flows will be dried. So we have a window of 12-18 months to revive the economy by building exports and attracting FDI. Otherwise, 2018 could be the dark year.
So better tread cautiously and simultaneously work on a model to boost economic growth and enhance productivity.
This article originally appeared in Business Recorder (BR) research on July 24, 2015.
