EVER since last summer when the government applied a historic monetary and fiscal stimulus to the economy a question has hung silently in the air, holding its poise through all the hype along the way around the current account surplus of 2020 and followed by the return of growth announced in early 2021. The question was a simple one: for how long will the stimulus, and its attendant pro-cyclical monetary and fiscal policies be allowed to continue?
Compare how the State Bank has talked about this question for a few months now. Until March the State Bank felt comfortable in its role to “support the recovery” via low interest rates. Those were the months when the current account deficit had made a return on a monthly basis, but cumulatively for the fiscal year, it was continuing in surplus. Times looked good back then. The rupee had risen to the low 150s against the dollar, manufacturing was powering on, the current account deficit had eased from December, the first month of its appearance since the five months of surpluses ended and the government’s first offering of Eurobonds since the pandemic began fetched $2.5 billion and saw decent participation.
But all was not well in the background. The government had just signed onto an IMF programme that month which was going to see the winding up of the stimulus. Under the programme, the State Bank was to become autonomous and fight inflation before anything else, meaning interest rate decisions would no longer have to “support the recovery”. Expenditures would have to be scaled back, with development spending restrained to Rs500bn in the forthcoming budget and current expenditures to Rs7 trillion. Power tariffs were to rise by Rs5 per unit in the summer months, probably one of the steepest increases ever. Altogether, the party was scheduled to end with the budget for FY2022.
It didn’t happen. Finance minister Hafeez Shaikh was unceremoniously ousted from the government days after signing this programme (even though it had been approved by the federal cabinet) and his replacement, Shaukat Tarin, was in no mood to wind up the stimulus. When the budget was announced in June, development spending had already overshot its committed quarterly target by more than 80pc, and was programmed at Rs900bn for FY2022, higher by 27pc from what had been committed.
By the month of May, six consecutive months of current account deficits had pushed the surplus for the fiscal year into deficit for the first time; in the next month it came in at $1.6bn, one of the highest monthly figures seen in a long time. This was the month the rupee started sliding against the dollar, falling slowly at first from 151 or 152 in the earlier days, to cross the 160 mark by July till it started touching 170 by September.
Through all this the State Bank found a silver lining, saying “unlike previous growth upturns in Pakistan, the current economic recovery has been achieved without compromising external stability”. It attributed rising imports to “one-off shipments of wheat and sugar” as well as higher international commodity prices, and found comfort in the growing remittances whose increase had outpaced the growth in the trade deficit. “Looking ahead, the current account deficit is expected to remain bounded”, it said in the May monetary policy statement, “modulated by the flexible exchange rate regime” while all external financing needs would be “comfortably met”.
But July and August brought little comfort. The current account deficit charged ahead, coming in at $2.2bn in the two months, larger than the preceding 12 months combined, with promises of more to come. Meanwhile, the government spent ferociously, disbursing 44pc of the full year development budget in these two months alone. By now, what began as a stimulus to mitigate the impact of the Covid lockdowns of a year ago had turned into a gravy train of relentless elite consumption.
In the monetary policy statement of Monday, the State Bank finally acknowledged that the vulnerabilities are growing faster than anything else in the economy, and the stimulus now needs to be unwound. “[T]he pace of the economic recovery has exceeded expectations,” the statement says. As a result, rising domestic demand and higher commodity prices in world markets are “leading to a strong pick-up in imports and a rise in the current account deficit”. With its customary bow to the Covid threat (which never rose enough to become a challenge to the economy in Pakistan), it is now necessary to shift the focus away from supporting the recovery to “keep inflation expectations anchored, and slow the growth in the current account deficit”.
To do this, it says, the policy focus needs to shift “from catalysing the recovery after the Covid shock towards sustaining it”. This involves a balancing act, and “this rebalancing would be best achieved by gradually tapering the significant monetary stimulus provided over the last 18 months”.
The statement warns of the dangers of getting overzealous in the pursuit of growth. Consumer loans will have to be scaled back “as part of the move towards gradually normalising monetary conditions” and interest rates may need to rise further. Equally important, tax revenue growth will need some “support” if expenditures are to continue on their present track, exports will need to rise and imports will need to be curbed through targeted measures, while “appropriate macroeconomic settings to contain import growth” will need to be put in place.
The exchange rate alone can no longer absorb the full impact of the deterioration in the current account. The good news is foreign exchange reserves remain strong, so there is no sense of an imminent crisis. But the imbalances are growing, and the State Bank has just issued last call on the stimulus and called for tapering to begin.
The writer is a business and economy journalist.
Published in Dawn, September 23rd, 2021