The State Bank of Pakistan’s (SBP) recent dollar cap and policy rates have worsened the economic crisis and there is a need for meaningful reforms to achieve sustainable growth instead of relying on policies that become a source of economic instability, according to the Economic Advisory Group (EAG).
EAG declared in a press release that during the fiscal year (FY) 2022-23, SBP maintained a significantly negative real interest rate despite the need to reduce the external financing gap to a more sustainable level. On a forward-looking basis, Pakistan’s real interest rate at the start of FY23 was in the range of around -7 percent. This is especially noteworthy because it was in stark contrast to the global trend.
Around the same time, according to the International Monetary Fund’s (IMF) October 2022 Financial Stability Report, the short-term median real interest rate on a forward-looking basis in Latin America had increased to 5 percent. Likewise, the median real rate for Asia and Central & Eastern Europe had increased to 1-3 percent. In contrast, according to Bloomberg, the real interest rate in Pakistan was the second lowest in the South East Asia region as of July 2022.
SBP’s Inflation Projections Are Flawed
EAG lamented that it is concerning how SBP continues to remain behind the curve. The recent statements by the SBP Governor make clear that the SBP’s inflation projections underlying its decision to increase the policy rate by 100 basis points are flawed. The SBP Governor asserted that the true value of the exchange rate was close to Rs. 230 per US dollar. The sharp rupee depreciation in the following days puts a question mark on the credibility of the SBP’s decision-making process behind the recent monetary policy decision.
Despite some concerns, the EAG had overall welcomed the 2021 legislation that granted greater autonomy to the SBP and adopted inflation targeting as the monetary policy regime. Unfortunately, the SBP has made no progress in achieving its stated objective of stabilizing inflation around 5-7 percent. As per the SBP’s survey of forecasters, the long-term inflation expectations continue to remain unanchored at close to 9 percent. The implied inflation expectations based on long-term government bond yields are arguably even higher. This suggests that the SBP will continue to miss its inflation target over the medium term.
Poor Use of Forex Reserves
The SBP’s performance in ensuring financial stability is also unsatisfactory. As of 20th January 2023, the SBP reserves had declined to only $3.7 billion. This decline in reserves can be traced back to September 2021. Since then, the SBP has used reserves to fund the gap between forex inflows and outflows, and in doing so, prevented the exchange rate from adjusting in response to market forces.
It is difficult to believe that during much of this period, policymakers at the SBP did not have information on the expected worsening in the global financial conditions, and the impending external debt servicing requirements in subsequent months. Yet, the SBP continued using reserves to bridge the financing gap, instead of using a combination of increasing the policy rate and resorting to a market-based exchange rate regime.
Debt Burden A Big Challenge in FY24
These policy decisions exacerbated the already precarious situation Pakistan faces today, due to the sharp increase in external debt servicing burden since 2013. The SBP Governor has stated that, excluding a $3 billion rollover, Pakistan still needs to make a payment of $2.2 billion under a bilateral-commercial arrangement, another $2.8 billion which he did not clarify, and $1.1 billion in interest payment during the next five months. With reserves already as low as $3.7 billion, the debt servicing burden during the next fiscal year will present an even greater challenge.
The EAG recognized the need for cooperation between the fiscal and monetary authorities to achieve desired macroeconomic objectives. It was also of the view that the SBP has fallen short of using the autonomy that it was granted by the parliament to deliver on its mandate. In effect, by insisting on preventing the exchange rate from fully adjusting while not backing it with an appropriate interest rate stance, the SBP only contributed to the instability that it was mandated to prevent.
The EAG concluded that the transparency that comes with the adoption of a stated inflation target under the inflation targeting regime plays a crucial role in making the central bank accountable.