LAHORE: The State Bank of Pakistan (SBP) has unveiled its monetary policy and set the policy rate at 12.25% for the next two months.
Media commentators and analysts are of the view that the rate hike cycle has not touched its peak yet and there is room for further rate increase keeping in view the expected pace of inflation.
In a developing economy like Pakistan, the SBP is trying to achieve the goal of low inflation through monetary tightening. In quick successions, the policy rate has been jacked up. These hikes would have deleterious consequences for the economy.
By looking at statistics, the government would emerge as the largest borrower from the banking system. This pattern emerged after the global financial crisis of 2008 since private banks adopted a cautious approach due to stock market crash and ensuing recession in Pakistan.
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Banks remained quite cautious till 2015 in extending loans to the private sector. The analysts lashed out at the government by bringing in the argument of crowding out.
In the context of a developing economy like Pakistan, the conventional crowding out phenomenon does not hold ground. This phenomenon becomes valid under certain conditions, especially when inflation is considered as a monetary phenomenon.
As far as the case of Pakistan is concerned, inflation is not a monetary phenomenon, though international financial institutions (IFIs) try to assert through conventional statistical techniques. By doing so, these institutions ignore the structural feature of Pakistan’s economy and availability of data.
Whenever a country goes for an IMF programme, the government is asked to borrow through commercial banks. The usual argument is that the government needs to borrow at high interest rate from the commercial banks. This way, the government will be bound to impose financial discipline and restrict its borrowing from the banking system.
This kind of financial discipline is better to appease the IFIs and international rating agencies such as Moody’s, Fitch and Standard and Poor’s. The assigned ratings given to sovereign developing countries help them to attract foreign portfolio investment. If a country’s foreign rating is good, it will help policymakers to woo global fund managers.
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This appeasement of the IFIs would deal a blow to the real economy. Walking on a tight fiscal rope in the grip of a recession normally creates political difficulties for democratically elected governments. These kinds of harsh fiscal adjustments are possible under technocratic governments where economics and politics are considered separate from each other.
In order to separate economics and politics, the IFIs demand independence of the central bank from the control of the Ministry of Finance. In addition, they may ask a technocrat to govern the central bank.
Practically, a central bank is an organ of a government which provides a natural link. The government can easily borrow from the central bank by selling its bonds and through ways and means mechanism. In the presence of a central bank, a government can’t be bankrupt.
When the IFIs direct the government to borrow from the commercial banks, they restrict this natural link. In addition, borrowing through banks becomes costly for the government and this will further squeeze fiscal space of the government.
Last but not the least, the government starts serving commercial banks by taking loans from them since extending loans to the state is quite safe for these banks.
In a nutshell, raising the policy rate in quick successions may temporarily attract hot money from the international fund managers. But this will be at the cost of the real economy and a bitter pill for the government to swallow.
The writer is the Assistant Professor of Economics at SDSB, Lahore University of Management Sciences (LUMS)
Published in The Express Tribune, June 10th, 2019.
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