The Pakistan Tehreek-e-Insaf (PTI) government was elected to office on the promise of creating ease of doing business, envisaging reduction of bureaucratic morass, lower utility rates for the business to propel their capacity in the economy, but it all became redundant when the State Bank of Pakistan (SBP) Governor Reza Baqir raised the interest rates to 13.25 percent on July 16, a 150 basis points increase.
Yet again, the state bank is set to announce its monetary policy on September 16 for the next two months, however the experts are predicting that the interest rate is likely to be fixed slightly downward with most of them predicting that the central bank will opt to reduce the rate by 25 basis points.
“Inflation rose considerably to 7.3 percent in Fiscal Year (FY) 19 due to higher government borrowings from the SBP, lagged impact of exchange rate depreciations, hike in domestic fuel prices, and rising food prices. Consumer Price Index (CPI) inflation was 8.9 percent in June 2019 and is expected to rise in the near term due to the one-off impact of adjustment in utilities’ prices and other measures in the FY20 budget. These pressures are expected to recede in the second half of the fiscal year and the Marginal Propensity to Consume (MPC) expects inflation to average 11 to 12 percent in FY20,” The SBP governor said, while giving a reason for raising interest rates on July 16.
However, after the May and July increase in the policy rate by the state bank, inflation failed to decline, in fact it rose. The rise in interest rate in theory should have raised the cost of capital, a key input to productivity, and concomitantly elevated the cost of borrowing by households which are significant in the perfect model of the economies. Thus a higher discount rate would lower aggregate demand and consequently inflation in advanced well documented economies.
The situation for Pakistan is different and has exacerbated over the time. The trust deficit between PTI government’s economic team and business community has widened as the rhetorical commitment of Khan’s government to generate an environment conducive for business has been divorced to the policy initiatives of technocrats in the economic team.
Instead of bringing its own house in order and correcting inflationary pressure through fiscal management by reducing government spending to decrease aggregate demand and thus the inflation, the government’s spending surprisingly increased exorbitantly. Last year the budget deficit was at 8.9 percent of Gross Domestic Product (GDP) while this year it is projected to escalate at 7.2 percent with current expenditure alone is due to rise by 31 percent. The ironic contrast makes the contractionary policy of the SBP at odds with the government’s fiscal policy.
The government may have given an unrealistic tax collection target to the Federal Board of Revenue (FBR) to collect Rs 5.5 trillion under the International Monetary Fund (IMF) package commitment; however it has consistently been on the adverse journey of expansive budgeted expenditure. As the IMF team is due to visit Pakistan, its spokesperson Gerry Rice said that one of the key elements of the IMF programme in Pakistan was the need to mobilise domestic tax revenue to fund the “much needed” social and development spending while placing debt on a “firm downward trend”. Hence, in order for the government to land at safe fiscal position it needs to handle its tools well instead of depressing the economy through contractionary monetary policy Khan’s economic team may not have been elected to the office but the government owes it to its constituents; to make things right, before Pakistan’s economy takes a turbulent course to deep recession.