The State Bank of Pakistan’s Monetary Policy Committee held an emergency meeting last week to raise the discount rate by 250 basis points — from 9.75 to 12.25 percent – a big rise indeed. The hike in policy rate has elicited a sharp reaction from the business circle.
The Islamabad Chamber of Commerce & Industry (ICCI) president has strongly criticised the SBP’s decision to jack up the benchmark interest rate to 12.25pc. According to him, the sudden jump in the interest rate would badly affect the growth of business activities and hurt exports. In a meeting of the business community of the federal capital, the ICCI president said the policy interest rate was 4pc in India, 4.75pc in Bangladesh, 3.7pc in China, 0.5pc in Thailand and 0.75pc in Hong Kong, but it had been increased to 12.25pc in Pakistan, which was almost the highest in the region. He warned that the massive hike in the policy interest rate would adversely affect all sectors of the economy and lead to further downfall in trade and industrial activities.
By all accounts, the latest SBP policy rate is a hefty rise necessitated by a number of complex economic factors, including a historic high of 35.39 billion dollars in trade deficit. On the other hand, the foreign exchange reserves had plummeted to 11.3 billion dollars due to repayment of debt including a syndicated loan facility from China and settlement of an arbitration award with Reko Diq, envisaging a 900 million dollar payment to Antofagasta Plc.
Also, last month core inflation covering non-food and non-energy items rose to 8.9 percent, headline inflation 12.7 percent and the Sensitive Price Index 16.79 percent, year-on-year. As pointed out by experts, the discount rate has been linked to headline inflation as a matter of policy decision by the State Bank of Pakistan since 2019. The rise in the discount rate implies a contractionary monetary policy but since the country’s fiscal policy is expansionary its impact on the rupee-dollar parity may be limited.
According to the Monetary Policy Statement, risks to external stability have risen which is evident from a continued improvement in the non-oil current account deficit. However, despite visible improvement in the non-oil current account deficit, the MPC decided to increase the interest on export refinance by 225 basis points — from 3 to 5.5 percent — and widened the set of import items (luxury items but excluding raw materials) subject to cash margin requirements.
It is relevant to add here that the political crisis in the country contributed to a 5 percent depreciation in the value of the rupee (from 178.6 rupees to the dollar on 8 March when the last MPS was held to 188 rupees to the dollar on 7 April) and a sharp rise in the domestic secondary market yields as well as Pakistan’s Eurobond yields and CDS spreads.
Overall, the decision to raise the discount rate indicates serious concern over the country’s deteriorating economic situation. It is reported that the reason for not raising the rates in March was pressure from the government which continued to use the exchange rate as a shock absorber, as per the advice by the International Monetary Fund (IMF) in the sixth review documents.
Among other things, the SBP in its statement noted that Pakistan’s external financing needs in the current fiscal year are fully met from identified sources. This statement is important for the IMF which has indicated that it will engage with the new government as it was one of its conditions throughout the programme which was highlighted in the staff-level agreement of May 12, 2019, notably “financing support from Pakistan’s international partners will be critical to support the authorities’ adjustment efforts and ensure that the medium-term programme objectives can be achieved.” That support was identified at a whopping 38.6 billion dollars in just 39 months by the then economic team leaders, with 10 billion dollars used for budget support as acknowledged by the Finance Ministry recently in parliament.
Objectively speaking, the decision to raise the interest rates, unwelcome for the productive sectors, was necessary. But to make the rise result-oriented it should be followed by appropriate policy decisions by the government on the fiscal side, including slashing of current expenditure. There is an urgent need for the new government to begin slashing unnecessary and wasteful expenditures. A new austerity regime should be enforced in order to make savings wherever possible. On the revenue side, instead of raising taxes, the tax net should be widened to cover many untaxed sectors with substantial earnings.