FeaturedNationalVOLUME 19 ISSUE # 4

Misplaced assumption and policy rate impact

The International Monetary Fund’s (IMF) recent insistence on linking the policy rate with headline inflation in Pakistan raises serious concerns. This approach seems ill-suited for the country due to its unique economic landscape. Unlike developed Western economies, the policy rate in Pakistan has limited impact on the general public, and the absence of collateral or a guarantor restricts borrowing.

Additionally, the virtually non-existent concept of mortgages and the predominant borrowers being the large-scale manufacturing sector and the government itself make this policy linkage problematic. The repercussions include heightened input costs, negatively affecting productivity and economic growth. Despite numerous changes in finance ministers and State Bank of Pakistan governors, the IMF has not been swayed from this approach since 2019.

The National Electricity Power Regulatory Authority (Nepra) and the Oil and Gas Regulatory Authority (Ogra) have once again given their approval for an increase in electricity and gas rates. The Nepra has raised the fuel charges adjustment by 3.07 rupees per unit, citing recent findings that all distribution companies overcharged and overbilled consumers by 100 percent. Even protected consumers, using less than 200 kWh per month, were consistently charged the rate of upper slab users. The Sui Northern Gas Pipeline Limited has increased gas rates by 137 percent, in addition to the gas rate rise effective from November 1 for all consumer categories. Protected consumer charges have surged from 10 rupees to 400 rupees, marking a 3900 percent increase.

While these price hikes are part of agreed conditions under ongoing multilateral programs, including the nine-month $3 billion Stand-By Arrangement of the International Monetary Fund (IMF), the stated economic objective is full cost recovery. It is noteworthy that administrations have consistently favored price upgrades over implementing structural reforms to reduce sector inefficiencies and alleviate the burden on consumers.

It is crucial to observe that subsidies previously minimized the public’s ability to bear the full cost of recovery. However, the country has now reached a juncture where multilateral or bilateral lenders are unwilling to extend loans without the implementation of structural reforms, potentially leading to a default.

Simultaneously, these recent administrative measures coincide with a 29.2 percent Consumer Price Index (CPI) for November 2023, a consistently high rate that has eroded the capacity of low to middle-income earners to meet their basic needs. The sacrifices required have significantly undermined their quality of life.

The country now faces a critical situation where there is no leniency from lenders, and the general public’s capacity to meet the rising cost of utilities is strained. Of particular concern is the IMF’s insistence, in both the ongoing program and the previous Extended Fund Facility program approved in July 2019, on linking the policy rate with the CPI. This is based on the assumption that adjusting the policy rate with headline inflation, which includes imported inflation, is a more effective strategy than linking it to core inflation (non-food and non-energy), as was previously practiced.

The assumption made by the International Monetary Fund (IMF) is clearly inappropriate for Pakistan for two significant reasons. First, unlike in the developed economies of the West, the policy rate in Pakistan has minimal, if any, impact on the general public due to severe limitations on their borrowing capacity, stemming from a lack of collateral or guarantor support. Furthermore, the concept of mortgages is nearly non-existent in the country. The primary borrowers from the banking sector in Pakistan are the large-scale manufacturing sector and the government itself. Consequently, any increase in the policy rate results in elevated input costs, directly negatively affecting productivity and the growth rate. Given the government’s heavy reliance on domestic borrowing, this has led to a continual rise in debt servicing costs.

The November 2023 Update from the Finance Division highlighted a substantial surge of 44.6 percent in mark-up payments, primarily attributed to a higher policy rate. Since 2019, no finance minister (including the seven who have served since then, including the current caretaker) or Governor of the State Bank of Pakistan (three, including the Acting Governor in 2022) has been successful in persuading the IMF to abandon the linkage between headline inflation and the policy rate, as it is simply not applicable to Pakistan’s unique circumstances.

It is hoped that the IMF staff acknowledges this fact and makes necessary adjustments. Otherwise, the ongoing inflationary pressures may lead to widespread civil unrest and further push the economy into a recession. This would make the implementation of essential structural reforms even more challenging from a political perspective.

As Pakistan grapples with mounting inflationary pressures and escalating debt servicing costs attributed to the IMF’s policy rate linkage, there is a pressing need for a reassessment. The Finance Division’s recent update underscores the substantial impact of a higher policy rate on mark-up payments. The IMF’s continued adherence to this policy in the face of Pakistan’s economic intricacies could potentially fuel civil unrest and plunge the economy further into recession. It is imperative that the IMF recognizes the inapplicability of this linkage and considers adjustments. Failing this, the implementation of vital structural reforms becomes an even more formidable challenge, particularly in the volatile political landscape.