If Pakistan were a person, he would probably be diagnosed with bipolar disorder.
Several trips to the main cities of the Persian Gulf; stunning performances at spring meets; a couple of Ted Talks in DC urging the primacy of “how” over “why”; a dash of the door to Davos and voila! Market confidence in Pakistan’s macroeconomic direction is restored. Commercial interests seem so desperate for good news on the external front that even a friendly wink from bilateral partners would set hearts aflutter. There is no need to know if there has been any real progress on energy reforms or what exactly the federal government’s plan is to bridge the fiscal gap. Finally, a tireless team of superheroes has taken over the reins of power and “the city of Townsville will be safe again”.
Apart from collapsed states like Haiti or active conflict zones like Syria, Pakistan still ranks among the top 10 countries with the highest inflation rates. The latest headlines remain the highest in the South Asia region: 5 times higher than India, twice higher than Bangladesh. And not to mention Afghanistan, which is at minus ten percent as of February 2024 (apparently curbs on smuggling have somewhat slowed inflation here, but completely suppressed it across the western border).
There remains a pervasive reluctance to loosen monetary screws at central banks around the world, made worse by the apparent absence of future guidance, see timeline for when easing might begin. Still, Pakistan wants to lead the world into the next great age of monetary liberalization. Never mind that the CPI is still 13 percentage points outside the SBP’s target range. Never mind that the last monthly reading turned out to be stubbornly sticky.
The central point of the discourse is the 12-month inflation forecast, which may seem rosy at first glance, but hides significant risks, arising mainly from volatility in the oil and energy markets. Premature easing risks accelerating capital outflows, exacerbating exchange rate pressures and fueling imported inflation.
Importantly, the MPC still lacks insight into the federal budget and whether it would continue down the stabilization path or be used to prime the pump. To insist that the federal government will not act out of desperation to secure a lifeline from politically significant commercial interests is to deny 75 years of political history. Let us not forget that the PML-N led organization in Islamabad is a minority government in all but name.
The path to stabilization of inflation from there is conditioned by the cooling of energy tariffs. Yet decision-makers have yet to publicly chart a path to achieving this elusive goal. Why is it so hard to believe that another round of energy rate hikes wouldn’t make the list of initial conditions for the next fund program? The country as a whole could use a break from energy inflation, but given our track record, the SBP would be well-advised not to consider the best-case scenario as its base case.
This uncertainty also extends to the area of foreign direct investment (FDI). Let’s be fair, if the agricultural investment opportunity presented to potential Arab investors was so compelling, plenty of local investors would have lined up long ago. More importantly, Egypt’s experience shows that when equity stakes are at stake, investment flows from the Gulf kingdom can take their sweet time to materialize.
While the allure of immediate relief may be tempting, the MPC should ask itself what purpose a rate cut at this stage could serve. An easing of up to 100 bps at a time when the prime rate is effectively at 22 percent would not really matter much to commercial and industrial borrowers. Not only would borrowing costs remain stubbornly high to make LSM growth green overnight. More importantly, for most short-term and long-term outstanding commercial bank deposits, the new rate would not start until the beginning of the next calendar quarter, on July 1.
Meanwhile, the SBP has another MPC meeting scheduled for June before the end of the current quarter. By then, the federal budget could even be tabled and timelines could also be moving higher up the IMF agenda, with greater visibility as to whether central banks around the world will decide to move closer to easing. Pakistan will also experience two more months of inflation, hopefully well below twenty percent.
The only participants desperate for a rate cut right now are stock market investors. Problem? As far as they are concerned, a 100 bps cut is not enough. If the SBP takes the easing path now, it would send a major signal to market participants. They would smell blood and soon be asking for more.
Therefore, the current SBP leadership would be well advised to take into account the lessons of the 2020-22 cycle and the devastation premature and excessive easing can wreak on the economy.