In May, consumer inflation rose from 13.4 percent in April to 13.8 percent. Meanwhile, the rupee, which fell to a historic low of 202 to a US dollar on May 26, rose gradually thereafter. It closed on June 2 at 197.59 per dollar in the interbank market, recovering 2.2 percent of its lost value.
Total inflation of 13.8 pc. demonstrates the persistence of inflationary pressures stemming mainly from continued domestic consumption, high international food and fuel prices and a weaker rupee. The 20 percent increase in local heating oil prices as of May 27, followed by another substantial price hike (Rs30 per liter) as of June 3, is expected to push inflation up further in June and even beyond.
The rise in fuel prices has already pushed up the prices of almost everything – from groceries to motorcycles and from cooked food to household electronics and from transportation fees to doctor’s fees.
Regaining the value of the rupee against the US dollar may prove temporary if it takes longer than expected to convince the International Monetary Fund (IMF) to revive its stalled $6 billion loan program and size to $8 billion.
Even if the IMF revives and expands its lending program sometime this month and we receive a new loan tranche that exceeds the planned size of $900 million, much more foreign exchange will be needed to keep the rupee stable.
The large increase in domestic heating oil prices has exacerbated the political problems of the new government. But the IMF wants the government to do more – also increase electricity and gas tariffs from July. Government officials say they will have to. This means inflation could remain in double digits in the July-September quarter and perhaps October-December as well.
This also means that the State Bank of Pakistan (SBP) will have to raise interest rates further in July to signal to markets its determination to contain inflation. (Between 7 April and 23 May, the central bank has already raised its key rate by 400bp to 13.75 pc in two tranches).
Although the central bank had started using inflation targeting earlier, inflation officially became the only top priority after parliament granted it additional autonomy during the ousted government of Imran Khan. Inflation targeting refers to a monetary policy framework in which a central bank does not have to worry about economic growth and job creation when making policy decisions.
Expecting to curb inflation with tighter interest rates is fine when inflation is just a product of higher demand for goods and services. That is of course the case, but only partly. Higher international fuel and food prices, existence of a large parallel economy, continued growth of the currency in circulation, failure of provincial governments to control prices of essential goods and services, political interference in market regulation by the Competition Commission of Pakistan and a weaker rupee also continues to fuel inflation.
In such a scenario, the rate tightening works only partially – and a delay that is longer than usual. That is exactly what is happening now. And that is why inflation cannot be moderated easily and seriously.
Despite a modest recovery, the rupee cannot remain strong as the weakness is rooted in structural problems in Pakistan’s external sector. Even if the IMF revives and expands its lending program sometime this month and we receive a new loan tranche larger than the planned size of $900 million, much more foreign exchange will be needed to keep the rupee stable.
The SBP will need to raise rates further in July to let markets know that controlling inflation is its top priority
The National Accounts Committee believes that in the new fiscal year starting in July, the country’s net external borrowing needs will be somewhere between $36 and 37 billion.
It is true that the IMF loan revival would pave the way for forex funds from other International Financial Institutions (IFIs), including the World Bank and the Asian Development Bank. But development loans from these two and other IFIs are program-based and trickle in slowly while Pakistan immediately needs a large inflow of foreign exchange to achieve sufficient forex reserves i.e. to ensure that SBP forex reserves are equal to at least three months of import duties for goods.
On May 27, SBP had just $9.773 billion in forex reserves — barely able to pay its month-and-a-half import bill. So what can be done right away?
The government is working closely with Saudi Arabia and China to request that both of them place several billion dollars each in SBP reserves. Riyadh has openly said it is considering extending the tenure of its $3 billion already assigned to SBP. But based on the realities of our external sector, it would be naive to expect Saudi Arabia not to charge higher interest rates this time around.
How soon Beijing can come forward to help and how much deposit it can make into the SBP coffers – and under what conditions still unknown. Even if Pakistan manages to get forex deposits from these two countries – or any other friendly country for that matter – these are only quick fixes and help little in correcting structural weaknesses of our external sector.
Those weaknesses include low export bases, low worker productivity, higher than regional average energy costs, inconsistent export promotion policies, no or very little focus on import substitution, and the national habit of living outside of it, fueling consumerism. and import bills high etc.
The previous PTI-led coalition government made visible efforts to increase remittances, which grew from $23.1 billion in 2019-20 to $29.4 billion in 2020-21. Even in this fiscal year, remittances have maintained an upward trend and based on 10-month data, remittances for the full year can be expected to exceed $31 billion.
Despite that, our current account deficit in the first 10 months of this fiscal year was $13.779 billion. The SBP had to use $5.82 billion from forex reserves to keep the country’s overall balance of payments green, the latest official statistics reveal. The situation in the external sector is worrying. Is it not?
Published in Dawn, The Business and Finance Weekly, June 6, 2022