The lack of steadiness in Pakistan’s economic progress is noticeable. Boom-bust cycles, in which fast economic expansion is followed by a crash, create uncertainty in people’s lives and make it difficult for firms to prepare for the long term. Delay in policy action to avoid overheating is one of the main causes of these repeating boom-bust cycles.
The State Bank’s Monetary Policy Committee (MPC) decision on Friday to raise the policy rate by 150 basis points and slow growth is a step toward achieving the aim of preserving stability while growing. In this backdrop, it’s critical to comprehend why the SBP moved the MPC a week early, the rationale for a 150-basis-point hike, and how the central bank sees monetary policy evolving in the near term to maintain stability while promoting growth. Before getting into these three major concerns, it’s worth noting that, notwithstanding Friday’s policy rate action, monetary policy remains supportive of growth, as seen by sustained negative real interest rates. This fiscal year, the SBP predicts growth of roughly 5%, which is a four-year high.
In the September Monetary Policy Statement, the MPC had already indicated that the highly accommodative monetary policy settings that had been maintained since the onset of Covid in March 2020 were no longer needed. This policy response helped Pakistan emerge from the Covid shock earlier and with much less economic damage than almost any country in the world. However, with growth improving continuously since last summer and fears surrounding the Delta variant receding, the MPC noted that it was appropriate to begin tapering the monetary stimulus to prevent overheating. Accordingly, the policy rate was raised in September and future moves were expected to be gradual in the absence of unforeseen circumstances.
Since then, however, things did not turn out fully the way the MPC had anticipated. In particular, inflation and the current account deficit have risen somewhat faster than expected because of both domestic and global factors. At the same time, prospects for economic growth have also strengthened further. Such variances between projections and outcomes have become more pronounced in the face of uncertainties related to an unprecedented shock like Covid. For instance, developments in international commodity prices and global inflation over the last few months have challenged central banks around the world.
When outcomes are different from projections, it is important to be forward-looking and recalibrate the best course of action given the updated information. It was in this context that the date of the MPC meeting was brought forward. In addition, learning from this experience and international best practice, the frequency of MPC meetings was also increased from six to eight times a year, enabling faster course correction in the event of any future material deviation of outcomes from forecasts.
In deciding how much to raise the policy rate, the MPC weighed several factors. Since the extent of inflation and current account developments had been moderately more than that anticipated at the time of the September MPC meeting, the pace of tapering monetary stimulus needed to be somewhat more than the gradual pace anticipated at that time. Even before the announcement that the MPC meeting was being brought forward, analysts had already priced in a hike of at least 100 basis points in the policy rate in the November meeting. After careful deliberation, the MPC came to the view that raising the policy rate by 150 basis points would strike an appropriate balance between protecting the outlook for inflation and the current account deficit while also supporting stable growth.
So where does Friday’s move leave us in terms of the future path of monetary policy? Since the MPC began providing forward guidance in January, it has been centred on two major components: (a) the end goal of mildly positive real interest rates and (b) the pace at which this goal would be achieved. The end goal remains the same. However, given the more than expected rise in inflation and current account deficits in recent months, it is appropriate that the pace of achieving it be somewhat accelerated. Friday’s rate action was a significant move in this direction. As a result, and given the currently available information, the MPC expects future moves to be smaller in magnitude, such that the path to mildly positive real interest rates is likely to be less steep from here.
When growth is strong, the path of least resistance may be to not take any action that may appear to undermine growth. After all, why not go along with the trend and avoid any action to risk unpopularity. If a bust ensues, blame can always be apportioned to external factors beyond the control of policymakers. Such a course, however, has to be avoided as it would perpetuate repeated boom-bust cycles as in our past. In this light, it is imperative to make a break from the past and gear policy to give equal weight to stability and growth; we cannot afford to let our history rob us of our future.