The State Bank of Pakistan recently increased the interest rate by 100 basis points (bps) to 16 per cent to curb inflation. In its statement, the central bank said that the decision was aimed at ensuring that “elevated inflation does not become entrenched and that risks to financial stability are contained, thus paving the way for higher growth on a more sustainable basis”. The SBP also identified higher food and core inflation as “key contributors” to elevated inflation.

In the given circumstances, for the government the cost of commercial bank borrowing has now become prohibitive. This means that the government will have to make further cuts in its development budgets because it will not reduce administrative expenses. The big rate rise will also dampen the demand for bank credit of the private sector thereby moderating the current growth momentum. The private sector’s fresh borrowing from banks would also become too expensive, thus forcing them to compromise on their business expansion plans, reduce output and even lay off workers. This is a major side effect of monetary expansion.

After the recent hefty rate increases, economists have raised questions whether monetary expansion is effective in controlling inflation. For too long, we have relied on monetary policy to control demand and inflation to cool down the heated economic activities. However, the inflation we are facing is more cost-push which cannot be curbed by the monetary policy tool. In this connection, experts have rightly pointed out that monetary tightening might reduce pressure on external fronts in the short run, but it will lead to a higher fiscal deficit.

Needless to say, the current bout of inflation is not demand-pull, so higher interest rates are not an answer to the problem. As it is, demand has decreased recently, easing pressure on import bills. These factors obviate the need for monetary tightening. Private sector credit has also shrunk and current account deficit numbers have gone down.

To offset the effect of imported inflation, we need to develop a targeted strategy to reduce import bills by restricting the completely built unit (CBU) imports of the auto sector, cutting energy electricity consumption by imposing full/partial work from home, early market closures, and slashing any nonessential imports that do not impact our exports.

No doubt, the IMF plays an important role in the current situation. So we should develop a targeted short-term policy to reduce imports on an emergency basis until we secure financing and work on medium to long-term policies to curb the trade deficit on a sustainable basis. For the past eight months, the ongoing rupee depreciation has also fueled inflation. Higher monetary tightening is supposed to contain inflationary pressures by suppressing demand but this would ultimately depress growth momentum and may even affect job creation.

Pakistan’s central bank’s mandate is to take care of both inflation and economic growth. In this context our effort should be to give maximum priority to developing indigenous alternatives for energy production. Such an approach will not only counter imported inflation but also create more jobs.

The main objective of our monetary policy should be to provide productive jobs to our unemployed labour force the bulk of which comprises youths. An increase in production through targeted monetary expansion will not lead to inflation and boost our foreign exchange earnings. We have examples of many countries like Argentina, China and India where monetary expansion by the central bank-created money has been directed towards productive labour. Our youth is our most valuable resource. Our policymakers should use the monetary policy tool to provide them with productive jobs. Curbing food inflation through administrative measures to resolve supply-chain bottlenecks and any necessary imports should also be a high priority. In the ultimate analysis, without structural reforms in tandem with targeted monetary policy, sustainable economic growth would remain a pipedream.