In the last monetary policy meeting, there was a unanimous decision of keeping the policy rate unchanged. One may wonder what has significantly changed in the last two months for at least 5 out of 9 members to opt for a rate hike. The official line is narration of four factors - The currency depreciation of 5 percent in December, oil prices hovering around $70 per barrel, global tightening mode, and narrowing gap of output to indicate a buildup of demand pressures.
These factors seem like fillers to justify a decision based on some other variables as the currency depreciation is itself a tightening measure, so it cannot cause rate hike especially when inflation is likely to remain subdued in the near future. The other factors, apart from high oil prices, were already visible but these did not warrant even a single member to vote for rate hike in November.
Plus, politically it is not a norm in Pakistan to take difficult decisions close to elections when such steps can adversely impact popularity. There is more to the story, and that is the same factor that compelled authorities to let the currency to slip last month. BR Research's hunch is that post-programme monitoring report presentation to the IMF board is due in February; and the fund's local representatives have increasingly stressed on both exchange rate adjustment and monetary tightening for a few months to keep external account imbalances.
The IMF is right in its approach as in current circumstances, it is better to preempt a crisis-like situation to avert an actual one. But authorities were not giving enough heed to current account woes which had started emerging since Oct16. Now when the Fund presents a bleak balance of payment of situation in Pakistan to its board, it would acknowledge the country's economic authorities realization of the gravity of the situation which is evident by both currency adjustment and interest rate hike.
The question is whether keeping the IMF happy is the motive behind initiation of tightening stance, and if that is so, why is the IMF nod so important. Well, the balance of situation is becoming precarious with every passing day and longer the oil prices remain high, sooner Pakistan could go back to the IMF.
The SBP reserves were at $13.5 billion as of January 19, 2018. Let's see how much funding is required for reserves to remain at the same level till December. The current account deficit can be assumed at $15 billion for Jan-December with an assumption of oil prices at $60/bbl. The principal foreign debt repayment is $6.1 billion for the next 12 months. Thus the gross requirement is around $21 billion; at best $4 billion can be raised from FDI and FPI.
Where would the rest of $17 billion be financed from? How much can the government fetch from international capital markets? How much more would China help? China provided $5 billion funding in FY17 and let's assume another $5 billion by December. We may raise another $2 billion from Euro and Sukuk as we have already fetched $2.5 billion in Dec17.
The gap would still be around $10 billion, we can let $3 billion of reserves to wipe out to keep the import cover at two months. The net need may still come around $7 billion; and we need multilaterals to fund some of it; and this, dear friends, need the IMF nod. Some of the money would come from here and there; hence at the assumption of oil at $60 we may or may not need to be in IMF programme by Dec18.
However, if oil prices remain above $70 per barrel, the possibility of negotiation with the Fund in an interim set up cannot be ruled out. Thus, invariably tightening is the right choice as it may help in curbing current account deficit. Hence, the SBP proactive approach is welcomed!