2 articles - aakash & umer

7/31/2019 2 Articles - Aakash & Umer

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B Y D R A S H F A Q U E H K H A N

D E C 1 4 , 2 0 1 0

LIMITS OF MONETARY

POLICY


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Inflation is on the rise in many countries in the Asianregion.

Rising food prices are found to be the major driverbehind inflation in the region.

The rising food prices are causing a surge in overallinflation, particularly in low income countries wheresuch prices account for a higher proportion of theinflation basket.

Rising food prices are of a major concern because they

represent a higher proportion of spending for the poorthan for the general population, especially in lowincome countries.


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Why are food prices on the rise in the region, including inPakistan?

Increase in food price is largely driven by externalfactors, primarily weather-related internationaldevelopments and the increasing incidence of financialspeculation in commodity markets.

Key crop harvests have been affected by adverse weatherevents, especially wheat production of major exporterssuch as Canada, Kazakhstan, Ukraine and Russia.

Wheat prices were further affected by the announcementof an export ban by Russia in August 2010.


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Inflation in Pakistan

The above analysis suggests that inflation in Pakistanis supply-side

In the absence of clear signs of an excess demand in

Pakistan tightening of monetary policy would thusbe ineffective to deal with the root cause of inflation.


6/20

Monetary Policy?

By tightening monetary policy, can we reduce foodprices, improve the writ of the state, preventgovernment to raise power tariff, force thegovernment not to pass on the rise of POL prices todomestic consumers, and stop the government from

borrowing from the Central Bank to finance budgetdeficit?


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Effects..

Dampening the general level of demand in theeconomy through further tightening of monetarypolicy is detrimental to growth, job creation andpoverty alleviation.

Especially, a higher discount rate is raising the entireterm structure of interest rates and hurting privatesector investment.

In such an environment growth would remain low,joblessness and poverty would continue to rise.


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Authors Views

The author has been advocating the pursuance of tight monetarypolicy until the last monetary policy announcement.

The last increase in discount rate was unjustified and the SBP, atbest, could have maintained a status quo.

Before taking any decision regarding monetary policy, the sources

of inflation must be identified. Simply tightening of monetary policy without finding the root cause

of inflation is bad economics. The Research Department believes that inflation in Pakistan is

driven by food inflation for which monetary policy is not the rightinstrument.

The Monetary Policy Department on the other hand, believes thatinflation is always and everywhere a monetary phenomenon.Therefore the approach to monetary policy continues.


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Suggestion

Prudent monetary policy requires finding the rootcause of inflation in the absence of demand pressure.

SBP should reconsider its monetary policy stance.

Last three years of low growth have thrown millionsbelow the poverty line and millions have joined thepool of the unemployed. With external balance ofpayments not so fragile, there is a need to review the

monetary policy stance.


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B Y : N A S I R J A M A L

O C T 4 , 2 0 1 0

POLICY RATE AMID FISCAL

SLIPPAGES


11/20

THE State Bank of Pakistan hiked borrowing costlast week for a second time in two months

The decision is an attempt to pre-empt inflationary

expectations in the economy


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It also sends a signal to government to implementtax reforms and resolve circular debt in the energysector to contain fiscal deficit and its inflationary

borrowings from the central bank, the SBP says, needs to bring its fiscal policy in line

with monetary policy objectives.


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The half a percentage point increase in the bank`skey policy rate to 13.50 per cent may notimmediately alleviate fiscal pressures or curb prices

inflation spiked to 13.23 per cent in August


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The central bank`s hawkish stance on interest ratesis unlikely to control inflation

A SBP official concedes that the rate hike will nothave immediate impact.


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The economy had been facing strong headwindseven before floods displaced

Inflation was higher than the budgetary target andthe fiscal deficit stood at 6.3 per cent of grossdomestic product (GDP) against the target of 4.9per cent last year.


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The floods forced government to cut its GDPgrowth forecast for the current financial year to 2.5from the original target of 4.5 and last year`4.1 percent

The SBP has revised upward its estimate ofinflation to 14.5 from its pre-flood forecast of 12.5per cent.


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The market was anticipating monetary tightening oninflation concerns and was pricing in up to 50bpshike in lending rates.

The benchmark 6-month T-bill, for example, hadincreased 30bps.

Scheduled banks were reluctant to invest money inT-bills of tenures more than 3-month in anticipation

of further increase of another 50bps in the ratesduring the November review.


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Financial analysts agree that the bank did not havemuch of a choice here because of the widespreadconcerns about fiscal imbalances and inflationarypressures, they insist that it should have waited forthe completion of the World Bank/ AsianDevelopment Bank assessment on the flood losses tothe economy before raising the rates.


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The fiscal pressures are likely to grow during thecurrent financial year and force the government to

borrow more from the SBP and the scheduled banksif its spending rises on account of post-floodreconstruction and rehabilitation and if it does nottake action to raise more revenue or the pledgedforeign assistance does not arrive.


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As expected, the business community has expressed its deepdispleasure over the decision to raise the credit costs, saying thecentral bank had ignored significant risks to economic growth bycontinuing its hawkish stance on lending rates.

It will not curb inflation. It will only increase cost of doingbusiness and discourage fresh investments, contends IrfanQaiser, a leader of the Pakistan Industrial and Traders

Associations Front

The next quarter will be crucial in forming an assessment of the

effectiveness of government efforts to contain the fiscal deficitand its inflationary borrowings from the SBP and the bankingsystem, according to the monetary policy statement.

2 articles - aakash & umer

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