In order to fight inflation and suppress aggregate demand, the State Bank of Pakistan (SBP) has increased the policy rate by 1 percent (100 basis points) to 9.75 percent. This is the second increase by the SBP within a month. On November 19, the SBP had increased the policy rate by 1.5 percent. The aim is to ease pressures on imports and reduce the current account deficit.
However, on the flip side, such measures increase the cost of capital and add to the cost of production. They also push up already high commodity prices and compound the government’s interest payments liabilities. According to experts, the mini-budget is likely to further curtail aggregate demand and reduce a much-needed stimulus and development expenditure. At the same time, more emphasis on indirect taxes is dampening domestic investment, in addition to contributing to the high imported inflation component and in turn hiking commodity prices further.
This is happening at a time when there is an urgent need to have a loose monetary and fiscal policy for economic recovery and reducing inequality and poverty. Besides, the government has not been able to manage the international supply shock through targeted subsidies, lowering of indirect taxes and improving governance for better functioning of markets.
We all know that poverty and inequality have increased due to the pandemic, overall economic slowdown and a severe world commodity price shock. At this juncture, when the economy needed an aggregate demand stimulus to create enough economic recovery to undo the impact of recession and diminishing purchasing capacities of the common people, efforts by the State Bank of Pakistan and other authorities to dampen aggregate demand will be counter-productive to the overall economic recovery needs. Needless to say, the existing clutch of policies will further exacerbate cost-push inflation.
What is the way out? Among other things, financial support from rich and advanced countries, and special drawing rights (SDRs) allocations by the International Monetary Fund (IMF) is a must for Pakistan and for other developing countries, which are also net importers of oil and face the consequences of a fast-unfolding climate change crisis.
Right now, Pakistan is in an IMF programme, with its rigid emphasis on difficult-to-implement conditionalities which have left policymakers in a quandary as to how to deal with the current account deficit, and also make necessary stimulus/development expenditures. In the given situation, the IMF needs to consider the limits of policy tools available with policymakers in both creating enough fiscal space for managing the negative consequences of the pandemic and international commodity supply shocks on the economy.
The IMF should also support Pakistan through enhanced allocation of special drawing rights (SDRs) in safeguarding foreign exchange reserves, allowing the country to better manage the current account deficit in a way that essential imports for economic recovery are sustained and the economy is better insulated from imported inflation. The IMF also needs to revise its policy of reduction in subsidies which should not only be increased but also better targeted.
It may be noted here that IMF officials talk of showing understanding for the important need of providing a stimulus and adequately spending in health and overall economic recovery, but at the operational level they keep pushing policies that lead to greater austerity and hardship to the people. The IMF should be less demanding with regard to conditionalities that lead to an increase in taxes and utility charges.
On the basis of its past experience, the IMF should understand the limits of its policy instruments and by concrete action honour its lofty public announcements of supporting developing countries’ stimulus and development expenditures. It is relevant to point out in this context that rich and advanced countries also have a moral and social duty towards developing countries, that is to provide adequate finances, and play a greater role in changing the multilateral frameworks that better meet the developing countries’ balance of payments and climate-financing needs.
On its part, the government should redouble its efforts to collect more revenue. The choice for Pakistan is clear. The government should formulate an economic recovery programme that reduces inequality and poverty. This involves not overly focusing on curtailing the current account deficit, but also a policy that diminishes any chances for broad-based economic recovery at the back of higher costs of capital, production, imported-inflation-led price shocks, and debt liabilities. We need to adopt a more aggressive economic diplomacy for arranging greater financial support, especially in terms of enhanced SDR allocations and climate financing and through smart curtailment of imports and much-improved governance of markets.