Deep concerns about interim monetary measures
The federal government’s decision to have a cabinet of 60-plus members and frequent visits of high officials abroad at a cost of millions of dollars hardly gives the impression that we are a nation facing an economic crisis
By M. Sharif

SBP raising discount rate by 200 basic points from 13.0 per cent to 15.0 per cent has strengthened the fears that IMF package will have hard conditionalities to be met. Although, the government was trying to play-down by saying that we will have the loan on so called ‘our terms’ but that was for public consumption only and in reality tough conditionalities were being accepted. Now, it is abundantly clear that fiscal and monetary policies are being tailored by tightening them well before the announcement of bail out package so as to dilute its impact for public consumption well before time. There is hardly any other rationale to justify increase in interest rate a few days before the package is to be announced. Why this spontaneous and hurried action?

The opposite viewpoint being that it is time to ease monetary policy that is already tight. A tight monetary policy did not achieve its main target of containing inflation during past more than two and half a year, even if one is to give weight to other factors that fuelled inflation.

Rationale of the inevitable

Inevitable, that is, IMF package with tough conditionalities has started showing up even before the package has officially been agreed to and signed. It is no secret that in these hard times IMF as a lender has stuck to its guns to lend. It has not eased its conditionalities and they are being imposed on countries seeking its credit line with equal focus on improving macro-economic stability and enabling them to pay back lender’s money. Ukraine, Hungry and Iceland, the three countries that have sought IMF lending a few weeks earlier have hiked discount rates. Iceland had to give a jump of 600 basic points, from 12.0 per cent to 18.0 per cent. Hike in interest rate is relatively soft for Pakistan because as authentic press reports indicate, IMF was insistent to hike discount rate by 5.0 per cent. Agreement has already reached for 3.5 per cent, to be executed in two phases; phase–I of 2.0 per cent hike is already implemented and phase-II of 1.5 per cent hike is to be implemented in January, 09.

One understands that hiking interest rates is the most unpleasant decision particularly when economy is in downturn mode, inflation has surged to 30-year high at 25.0 per cent, country is under debt burden of more than Rs3.2 trillion with foreign debt of $47 billion, poverty is up, forex reserves have depleted by $5.0 billion and are depleting at a rate of $1.0 billion per month and current account deficit during first five months of current fiscal year has increased to $5.9 billion. But, what is more unpleasant than that is the way interim monetary policy justifies hike in discount rates. There is a lot of truth when the statement says, “diagnostics of Pakistan economic situation is different from global and regional development, therefore policy responses have to be different.” But, have policy responses catered to address real issues faced by the economy?

Fiscal measures include end of subsidies on petroleum products and electricity tariff and 1.0 per cent increase in GST. Government’s borrowing from the SBP from July to 8 Nov, 08 stood at Rs369 billion, imports have increased by 35.2 per cent and trade deficit was registered, $7.45 billion.

The report states, “In contrast, Pakistan hit by the global price shock and given the delay in pass through of this price effect, witnessed a growth in its fiscal and external current account deficits that reached unsustainable levels and alarmingly high inflation -- since there are significant differences in ‘diagnostics’ among Pakistan and other countries, thus it must be recognised that policy solutions will also be different.” There could be hardly any difference about the diagnostics; the reservations of the many stakeholders and analysts are about the solutions that monetary measures cater for.

Real issues of economy are: high demand and low supply, high cost of inputs of production of industrial products and agriculture commodities, high inflation and depleted forex reserves. Over-all effect of these issues on economy is high rate of unemployment, low productivity resulting into depressed economic growth. To address these issues monetary and fiscal policies have to work in tandem with each other; they hardly worked the way they should have worked so far. This has also been implicitly accepted in the report.

The measure to hike discount rate, once again, is an exclusive measure taken for the reasons already stated. Public support to the policies of the SBP and government is essential for their successful implementation. It can be safely concluded that, to start with, things are not moving in the right direction.

Implications

How would making capital expensive by 2.0 per cent whose impact in banking sector will be ballooned to no less than 5.0 per cent that would raise discount rate of commercial banks to more than 20.0 per cent, help to contain cost of inputs, increase productivity and contain inflation?

Economy is already in recession and increase in discount rate coupled with cut in PSDP is likely to constrain economic growth further. Pakistan has already experienced low growth of 3.2 per cent from 2000 to 2003 primarily because of IMF conditionalities. It will be repeating history and issues like poverty alleviation and social sector development will be relegated in the background.

What should have been done?

It is certain that efforts were made to convince IMF officials during negotiations in Dubai, not to push for hiking interest rates that are already high. IMF officials should have been further convinced to wait at least till finalisation of the package. The government has limited options. SBP and the government can initiate austerity measures simultaneously to convey a strong message to stakeholders in particular and the public at large that they are not alone during this hard time.

 The latter should initiate austerity measures at all tiers of the government and public life to create a national urgency that ‘we are in trouble’ and need to act in as ‘one nation.’ Federal government’s decision to have a cabinet of 60 plus members and too frequent visits of high officials abroad that cost huge foreign exchange hardly gives the impression that we are a nation facing worst economic crisis.

It is estimated that expatriates and rich citizens of the country have around $200 billion in their accounts abroad. They should be inspired by removing credibility deficit and fears that are perhaps at their peek at present, to come forward to help the country. In such a crisis leaders are to rise to the occasion.

Conclusion

Interim monetary measure of hiking discount rate is a red signal. How to make it green? The government and the SBP should come up with fiscal and monetary incentives to improve productivity and reduce bank spreads. They should go all out to reduce credibility deficit and win confidence of the people. That is how the South Koreans succeeded to beat the financial crisis of 1997-98. We need to emulate them.