Pressure builds on PTI govt to loosen purse strings
Current account surplus is achieved at cost of living standards, employment
PHOTO: REUTERS
LAHORE:
Stabilisation measures have started to take root with the completion of the first quarter of the fiscal year 2019-20.
The effects of rupee devaluation are palpable now since they come with a lag. The most pronounced effect is the high headline inflation, which is hovering around 11.4%. Core inflation is around 8.4%, which is in a stable range.
Normally, the target of the central bank is core inflation. The State Bank of Pakistan (SBP) has jacked up the policy rate to 13.25% and is eying inflation of 10-11% since it intends to maintain a positive real interest rate.
The focus on positive real interest rate has increased to avoid capital flight and even attract foreign capital as foreign exchange reserves are in a tight range.
There is a lot of debate in the media about the repercussions of the high policy rate. Some commentators are of the view that the policy rate will remain at this level till early next year. Others are of the opinion that it should come down since core inflation has not increased to a great extent.
This debate diverts attention away from the main problem facing the economy, which is structural in nature - the balance of payments constraint.
The economy has been experiencing this constraint since long and successive governments have not paid attention to addressing the problem in a durable manner. Instead, these administrations tackled the problem in an ad hoc manner.
In the past, governments did depend on geo-strategic rents to overcome this constraint. Although these rents are still there, their magnitude has reduced a great deal. When geo-strategic rents are low, then the governments have recourse to the International Monetary Fund (IMF).
A political government comes to power for five years and the last two governments took the IMF programme as soon as they assumed power. These programmes ran for two to three years in tenures of previous governments.
The governments came out of these programmes around two years before the election. In the last two years of their term, these governments tried to appease the masses by reactivating the economy. This reactivation is done through relaxed monetary and fiscal policies.
The current government spent the first year seeking assistance from friendly countries. However, the gross external financing requirement of the economy is quite high, which friendly countries could not meet.
In addition, the government came up with a mini-budget to appease the industrialists but that also could not bring desired results.
Under a precarious external situation, the government signed the Extended Fund Facility (EFF) with the IMF. Like the previous programmes, this programme is not home-grown.
The IMF proposed orthodox measures such as revising up energy prices, tightening fiscal and monetary policies and letting the rupee depreciate. The economy experiences these orthodox measures, but desired results cannot be achieved.
These orthodox measures are a prelude to recession in the economy. As recession kicks in, imports start declining and the current account balance turns into surplus. That is the reason it is being said that the economy is on the mend.
However, this current account surplus is going to be achieved at the cost of general living standards and employment.
In a nutshell, the ongoing recession along with double-digit inflation may continue for some time. However, the pressure is building on the government to reactivate the economy by loosening purse strings and reducing the policy rate.
This shows that the trade-off between macroeconomic stabilisation and populist measures have become visible. Let’s see how the government reacts to the emerging situation.
The writer is the Assistant Professor of Economics at SDSB, Lahore University of Management Sciences (LUMS)
Published in The Express Tribune, October 7th, 2019.
Stabilisation measures have started to take root with the completion of the first quarter of the fiscal year 2019-20.
The effects of rupee devaluation are palpable now since they come with a lag. The most pronounced effect is the high headline inflation, which is hovering around 11.4%. Core inflation is around 8.4%, which is in a stable range.
Normally, the target of the central bank is core inflation. The State Bank of Pakistan (SBP) has jacked up the policy rate to 13.25% and is eying inflation of 10-11% since it intends to maintain a positive real interest rate.
The focus on positive real interest rate has increased to avoid capital flight and even attract foreign capital as foreign exchange reserves are in a tight range.
There is a lot of debate in the media about the repercussions of the high policy rate. Some commentators are of the view that the policy rate will remain at this level till early next year. Others are of the opinion that it should come down since core inflation has not increased to a great extent.
This debate diverts attention away from the main problem facing the economy, which is structural in nature - the balance of payments constraint.
The economy has been experiencing this constraint since long and successive governments have not paid attention to addressing the problem in a durable manner. Instead, these administrations tackled the problem in an ad hoc manner.
In the past, governments did depend on geo-strategic rents to overcome this constraint. Although these rents are still there, their magnitude has reduced a great deal. When geo-strategic rents are low, then the governments have recourse to the International Monetary Fund (IMF).
A political government comes to power for five years and the last two governments took the IMF programme as soon as they assumed power. These programmes ran for two to three years in tenures of previous governments.
The governments came out of these programmes around two years before the election. In the last two years of their term, these governments tried to appease the masses by reactivating the economy. This reactivation is done through relaxed monetary and fiscal policies.
The current government spent the first year seeking assistance from friendly countries. However, the gross external financing requirement of the economy is quite high, which friendly countries could not meet.
In addition, the government came up with a mini-budget to appease the industrialists but that also could not bring desired results.
Under a precarious external situation, the government signed the Extended Fund Facility (EFF) with the IMF. Like the previous programmes, this programme is not home-grown.
The IMF proposed orthodox measures such as revising up energy prices, tightening fiscal and monetary policies and letting the rupee depreciate. The economy experiences these orthodox measures, but desired results cannot be achieved.
These orthodox measures are a prelude to recession in the economy. As recession kicks in, imports start declining and the current account balance turns into surplus. That is the reason it is being said that the economy is on the mend.
However, this current account surplus is going to be achieved at the cost of general living standards and employment.
In a nutshell, the ongoing recession along with double-digit inflation may continue for some time. However, the pressure is building on the government to reactivate the economy by loosening purse strings and reducing the policy rate.
This shows that the trade-off between macroeconomic stabilisation and populist measures have become visible. Let’s see how the government reacts to the emerging situation.
The writer is the Assistant Professor of Economics at SDSB, Lahore University of Management Sciences (LUMS)
Published in The Express Tribune, October 7th, 2019.