Uzma Noreen
The second edition of IMF’s World Economic Outlook (2023) forecasted Pakistan’s GDP growth rate to 2.5% and raised the country’s anticipated inflation rate to 23.6% for FY24. Amid slowly declining global core inflation, IMF advised central banks to avoid prematurely easing monetary policy. The IMF’s recommendation of a tight monetary policy across globe is a universal prescription, kind of one-size-fits-all solution, rather than taking into account the local economic situation of different economies. For instance, despite the economic depression that the Pakistan is experiencing, IMF recommendations of fiscal austerity and maintaining an incredibly high interest rate would reduce public and private investment hence deepening Pakistan’s stagflation. Moreover, monetary contractions have welfare implications (increase poverty, worsen the inequality and unemployment) as highlighted in Social Footprint of Monetary Policy by Javed (2021). He stated that, “In 2018–19, the SBP raised the interest rate from 6% to 13.2% in less than a year in order to manage the growing current account deficit and balance of payment crisis. The GDP growth rate decreased from 4.8% to 1.9% as the economy slowed down, and large-scale manufacturing saw a steep decline. Industries were shut down. Poverty struck millions of people. The balance of payment was settled at the cost of millions losing their jobs and livelihoods. There can be serious repercussions for a society when large distributional and intergenerational issues are ignored in policy decision”.
Even though Central banks around the globe have been using demand management strategies such as interest rate instrument to dampen the inflation, but this kind of monetary policy fails to account for supply shock disruptions. State Bank of Pakistan also raise the policy rate to control inflation, however, since inflation in Pakistan is not demand push but caused by supply side factors particularly food shortages and hike in energy product prices. In the face of supply shocks, which can lead to cost-push inflation, central bank might choose to look through and tolerate a temporary deviation from their inflation target. For example, in 2011 UK saw a few instances of cost-push inflation when it increased above 5%, primarily as a result of a substantial increase in global energy prices and depreciation of the pound. The monetary policy committee of Bank of England, however, did not raise the interest rate, when the shock subsided and the inflation rate returned to the target level of 2%. As mentioned, Pakistan’s high and persistent inflation is mainly cost-push, rendering interest rates an ineffective instrument, so advising monetary tightening will entail real economic losses for the society and exacerbate the country’s economic problems. In addition, interest rate inflating would raise the cost of borrowing for the formal sector already suffering from low-capacity utilization due to an import crunch. Keeping a record high interest rate make it difficult for businesses to grow as cost of doing business is rising. Many existing firms have been closed due to unsustainable borrowing cost, which further increase the economic losses in the form of unemployment and low output.
As per the Forbes Report (Aug 2023) , globally Pakistan is among top ten countries with very high interest rate. While in the Asian region, Pakistan has the highest interest rate (i.e. 22%) as compare to India (6.5%) and Bangladesh (6.5%). The high credit cost affect the competitiveness of already struggling export industry in the region. Also, high interest rates is widening the fiscal deficit with significant increase in domestic debt in addition to raising the interest payment manifold (Since now the share of the floating rate debt is higher as compare to fixed rate). So, it is evident that IMF policy recommendation of old instrument of stabilization policy in the form high interest rate is actually worsening the debt sustainability indicators for Pakistan economy. IMF analyst also observed that lower average inflation forecasts are linked to more sustainable budgetary positions. However raising interest rate would only increase the cost to the government thus making the fiscal position more unsustainable. So how could this policy guideline of contractionary monetary policy in the form of high interest rate ensure the fiscal sustainability?.
The IMF Report also highlights that fiscal support measures could be useful in reducing inflation or at the very least smoothed out a severe inflationary shock. Nevertheless, the report doesn’t discusses the effects of the monetary tightening and fiscal austerity measures that IMF recommended to developing economies like Pakistan in order to use its funding facility. “It is generally argued that monetary policy actions transmit their effects on key macroeconomic indicators with a considerable lag and with a high degree of volatility and uncertainty. Empirical evidence reveal that the interest rate influences the rate of inflation with a lag of 12 to 18 months, and the magnitude of this impact is very small while some studies show positive relation. Additionally, empirical data for Pakistan demonstrates that the recent increase in interest rates has not significantly reduced inflation”. For instance, despite sacrificing growth, SBP’s monetary tightening failed to achieve the target of price stability.
Since the policy of increasing interest rate to reduce inflation has failed, so the interest rate should be reduced to boost the business activity. Further, it will also help the government to improve fiscal outlook in the short term. However, monetary policy itself is unable to achieve the targets unless fully supported by fiscal policy, deregulatory measures, and enhancing supply side shift factors like investment, enhance the productive capacity, and competition. Even though fiscal space is very limited at this time, but certain measures (along with reducing policy rate) which includes widening tax base (rather than increasing tax rates), reforming power sector (major source of circular debt), promoting public private partnerships (PPP) and coordinated monetary and fiscal policies would help to achieve the growth, employment and price stability targets. As highlighted by PIDE Reform Agenda, “moving to a high and sustainable growth trajectory calls for breaking away from the past, which is possible only if we undertake deep-seated structural reforms in almost all areas influencing growth”.
Writer is PhD Student at PIDE .She can be reached at [email protected]
