According to the Economic Advisory Group (EAG), the State Bank of Pakistan (SBP) recent dollar cap and policy rates have exacerbated the economic crisis and there is a need for significant reforms to create sustainable growth rather than relying on policies that become a source of economic instability.
EAG stated in a press release that despite the necessity to close the external financing deficit to a more manageable level for the fiscal year (FY) 2022–23, SBP maintained a considerably negative real interest rate.
At the beginning of FY23, Pakistan’s real interest rate was in the neighborhood of -7 percent. Being in sharp contrast to the general tendency, this is particularly remarkable.
Approximately at the same time, according to the International Monetary Fund’s (IMF) October 2022 Financial Stability Report, Latin America’s short-term median real interest rate had risen to 5%.
The median real rate for Central and Eastern Europe and Asia has also risen to 1-3 percent.
In contrast, according to Bloomberg, Pakistan had the second-lowest real interest rate in Southeast Asia as of July 2022.
SBP Projections of Inflation are Inaccurate
EAG expressed regret regarding SBP’s continued lag in technological advancement. The SBP’s inflation estimates, which served as the foundation for its decision to raise the policy rate by 100 basis points, are clearly erroneous, as evidenced by the Governor’s most recent remarks.
The governor of the SBP claimed that the actual exchange rate was close to Rs. 230 for every US dollar. The credibility of the SBP’s decision-making process behind the most recent monetary policy decision is called into question by the significant depreciation of the rupee that occurred in the days that followed.
The legislation enacted in 2021 that gave the SBP more autonomy and implemented inflation targeting as the monetary policy framework was generally welcomed by the EAG, notwithstanding some reservations.
Unfortunately, the SBP’s declared goal of stabilizing inflation at 5-7 percent has not been accomplished. Long-term inflation predictions continue to be unanchored at close to 9%, according to the SBP’s survey of forecasters.
On the basis of long-term government bond yields, implied inflation expectations are probably substantially higher. This means that over the medium run, the SBP will continue to miss its inflation target.
Misuse of Foreign Exchange reserves
In order to maintain financial stability, the SBP has performed poorly. The SBP reserves has decreased to just $3.7 billion as of January 20, 2023. Starting in September 2021, there has been a decrease in reserves.
Since then, the SBP has funded the difference between forex inflows and outflows using reserves, which has prevented the currency rate from fluctuating in reaction to market factors.
It is unlikely that policymakers at the SBP were unaware of the predicted deterioration in the state of the world’s finances and the upcoming need to service external debt during a large portion of this time.
However, the SBP persisted in using reserves to close the funding gap rather than combining raising the policy rate with switching to a market-based exchange rate system.
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