Theoretically, tightening the money supply and depressing the aggregate demand to tame inflationary pressures is the right policy. But, when it comes to single policy intervention, governments’ homework doesn’t seem well done. After the pandemic caused loss of growth and output, the Russia-Ukraine struck another lethal blow to the economies of the world. Developing nations are facing harder times in terms of importing expensive oil and using tight monetary policy.
Pakistan is currently facing a double-digit inflation with slow growth. It is in a clear situation of stagflation. The tight monetary policy further adds fuel to fire. The State Bank's monetary policy committee decided to hike the policy rate by 125 basis points earlier this month. The policy rate now has reached 15 percent. A continuous monetary tightening since last September has posed a question mark on the growth implications of Pakistan.
Theoretically, tightening the money supply and depressing the aggregate demand to tame inflationary pressures is the right policy. But, when it comes to single policy intervention, governments’ homework doesn’t seem well done.
The country’s business community is being discouraged in times when the country is in a dire need of an investment boom. Interest rate hike in the footsteps of the FED Reserve can be beneficial in terms of curing rising inflation. But, has Pakistan done well in this regard? The answer is no. Inflation is continuously rising while investment is becoming more expensive.
Joseph E. Stiglitz in his recent piece, Inflation Do's and Don'ts, says, "Higher interest rates will not lead to more cars, more oil, more grain, more fertilizer, or more baby formula. On the contrary, by making investments more expensive, they may even impede an effective response to supply-side problems.”
Pakistan has been a vulnerable country in times of global recession because of the policy response in times of shocks. Tight monetary policy in tandem with tight fiscal policy always bears bitter fruits and shakes the economy off the sustainable path. Keeping in mind the post-pandemic global scenario, Pakistan must have pursued the need for an IMF loan without fiscal tightening. The IMF deal seems a sigh of relief, according to the government and the analysts, but it is unlikely to ignore the dollar flight, expensive business, declining output, and cost-push plus the tax-driven inflation in the country. To get the deal much has already been sacrificed.
The government has imposed aggressive austerity measures. To assure the IMF about the fiscal cut, it has withdrawn subsidies from food items and has imposed GSTs on multi-type production and sale. However, parallel to this, infrastructure developmental projects are continuing in the country. This government spending is surprising when the country is on the verge of default. Perhaps, development projects, such as road expansions and transport services, can be put on halt for now.
The IMF deal is final now. We have no way to run from it as Pakistan is on the verge of default. Saudi Arabia and China will also come forth with loans once the IMF bailout package warms the economy.
Expensive imported fuel as input to production is raising the cost of production which is further feeding inflation and impeding output growth. Thereby, the government should reduce the GST on specific petroleum products till the time the global crisis settles.
Both monetary and fiscal policies are damaging the economy. Monetary policy contraction is absurd because the SBP has to follow textbooks, while, fiscal policy is only for securing package from the IMF. This must be stopped at least for some coming months. There is substantial danger in pushing the interest rates high. Tight monetary policy is for good times only when growth is plentiful amid the rising prices. In bad times, a good fiscal policy must be planned and opted.
The IMF deal is final now. We have no way to run from it as Pakistan is on the verge of default. Saudi Arabia and China will also come forth with loans once the IMF bailout package warms the economy. The government must decide the economic plan. The economy of Pakistan needs to be settled through most needed fiscal policy. The government must not shoot from shoulder of the central bank. If it wants to tackle the slowing growth and rising inflation, it has to come up with a broader fiscal plan. Because, low foreign investment, depleting forex reserves, increasing inflation and interest rate hike, and shrinking domestic investment is pushing the country in the black hole of default. Even if we get the IMF loan in days or hours, it will be of no use without a fiscal plan.