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Any further hike in policy rate can prove fatal for Pakistan

The good news is that the International Monetary Fund (IMF) has succeeded in convincing the Government of Pakistan (GoP) to agree on stringent conditions to pave way for the approval of US$6 billion under Extended Fund Facility (EFF). The bad news is that there will be further increase in policy rate, hikes in electricity and gas tariffs and reduction in subsidies. It may not be wrong to say that despite release of paltry tranches of US$2 billion per annum, Pakistan is likely to plunge deeper into debt trap, unless appropriate policies are implemented to restore competitiveness of Pakistani exporters in the global markets, a must for boosting exports for containing current account deficit.

IMF’s initial press release clearly highlights the need for 1) further adjustment in utility rates and 2) more fiscal consolidation primarily through enhanced revenue collection. These along with further weakness in rupee should translate into higher inflation going forward. Analysts anticipate average 10 percent increase in electricity and gas tariffs that would raise average inflation estimates by 60bps.

Like usual, State Bank of Pakistan (SBP) will be asked to further increase the policy rate to curb inflation. The Monetary Policy announcement is scheduled for 20th May 2019. There are market expectations that the central bank may announce hike in policy rate by 100 to 200 basis points (bps). The rationale being put forward is that May 2019 headline inflation may raise to 9.62%YoY as against 8.82%YoY recorded in April 2019 and 4.19%YoY recorded in May 2018. This would mark a five year high – a level last seen in late 2013.

First of all it is necessary to understand the logic behind announcement of Monetary Policy on 20th May rather than a routine announcement in last week of the month. Analysts see two reasons behind this move: 1) to enhance market participation in the upcoming T-Bills and PIBs auctions (scheduled for 22nd and 29th May respectively as the current uncertainty may limit the participation and 2) policy guidance through a press release to avoid bitter questioning by the media.

It is an irony that policy makers living under the illusion of IMF believe that they could contain inflation by increasing policy rate, which negates the ground realities. According to a report by one of Pakistan’s leading brokerage house the factors driving the headline inflation higher include: 1) rising food prices and 2) transport and fuel costs, a trickle down effect of higher international oil prices and a weaker rupee. Therefore, the hike in policy rate will further increase the inflation, rather than containing it.

It is also necessary to bring to the notice of policy makers that weaker rupee, hike in utility tariffs and new budgetary measures are all inflationary. It has been highlighted time and again that medium-term inflation outlook depends on the type and size of adjustment undertaken under the IMF program. While analysts await the granular details to assess the impact of upcoming adjustment on inflation outlook, the IMF’s initial press release clearly highlights the need for further hike in utility rates and revenue collection, which are likely to fuel inflation in the country.


Developing a local recipe

Though, the IMF certainly does like criticism on its policies, it is necessary to propose an alternative strategy for overcoming three deficits hurting Pakistan that are confidence deficit, budget deficit and current account deficit. These are so badly intermingled that addressing one is bound to aggravate the other two. By agreeing to the proposed package the incumbent government headed by Imran Khan has got a big jolt to the confidence of his party. It is openly said that the person who was the biggest critics of borrowing has bowed down before IMF to save his rule. While critics may have all the arguments, under the prevailing geopolitical situation Khan had no other option. Friends were generous but were they were also bogged down in their own problems. Petro-dollar income of Saudi Arabia faces uncertainties and its involvement in geopolitical issues are hurting its image. UAE may be generous but clouds of war are getting thicker, which can hurt its economy badly. China is facing trade war and hurdles in its CPEC program. Therefore, whatever the friends have provided should be considered ‘sufficient’.

It is true that Pakistan faces enormous budget deficit, but it can’t be overcome by introducing new taxes or withdrawing subsidies. Tax collection can be improved by accelerating GDP growth rate and enhancing spending by individuals. Since almost every item is taxed in the country, enhanced spending will also automatically boost indirect tax collection. Imposing new taxes or hiking the rate encourages people not to disclose their real income and avoid tax payment. Some experts have been demand reduction in taxes to boost overall collection based on the theory that lower the taxes greater is the disclosure and payment. It may also be remembered that manufacturers simply pass on the tax to buyers.

The current account deficit can’t be contained by curbing imports because it proliferate smuggling. On top of all Pakistan’s economy is heavily import based and the curbs affect the output of local manufactures. Failure to achieve economy of scale on one hand increases cost of production, and on the other hand does not allow them to produce exportable surplus. Textiles and clothing, sugar, fertilizer and refining sector are not only producing exportable surplus but earning extra foreign exchange. They do not demand incentives but simply bringing interest rate and energy cost down.

IMF must give sympathetic hearing to these suggestions if it is keen in pulling Pakistan out of the prevailing mess, else it should be ready to hear that IMF does not want countries to overcome their problems but live under perpetual state of miseries. If living under structural adjustment programs for decades have not allowed Pakistan to overcome its weaknesses, who is at fault, Pakistan or IMF?

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