However, till March 2018 policy meeting, the monetary policy committee was seemed confused on the economic challenges. "Recent adjustments stemming from greater exchange rate flexibility, active monetary management as well as visible improvements in exports and remittances are expected to bear fruit for medium-term in terms of sustaining the growth momentum without posing a risk to stability," read the statement back in March 2018.
The narrative was for tightening policies to bring stabilization in Jan18 which was flipped in Mar18, and challenges reappeared in May18. The change in policy narrative could be linked to the latest monthly numbers at the time of announcement. For instance if exports grew by double digits in a month, the stabilization was deemed to be achieved and vice versa. In none of these policies was there an emphasis on checking growing fiscal deficit which is at the core of economic woes. No currency adjustment, no interest rate hike, no other measures to curtail imports or to promote exports can work; unless the fiscal deficit is managed.
Why is the current account deficit high in Pakistan? It is primarily because of high imports growth. Why have the imports kept on growing in high double digits for the last couple of years? Apart from oil price hike, the growth in machinery imports for infrastructure expansion, which is predominately done by federal and Punjab governments, kept a tap on imports. High than expected government expenditure also generated excess demand.
The fiscal deficit, which was targeted at 4.1 percent in FY18, has reached a whopping 6.8 percent by the year end. This slippage of 2.7 percent or Rs 920 billion is probably triggered by the aggregate demand. The SBP Governor emphasized on managing the aggregate demand to lower external imbalances.
The current account deficit reached $16.0 billion in 11MFY18 which is 1.4 times, the last year's number and in the absence of matching financial flows; the deficit is financed by net reduction of $6.7 billion in the SBP reserves. Now the SBP ammunition is empty and it simply cannot let the reserves go further down.
The need is to curtail the current account deficit; especially the import bill. The measures taken so far have not worked including the currency depreciation by 13.8 percent against USD and over 15 percent against other trading partners. Imports have kept on growing, based on PBS data, on yearly basis, the import increase was 13 percent in 4QFY18 while on quarterly basis, the hike was 8 percent. Barring, petroleum and machinery imports, on yearly basis, the 4QFY18 imports growth is 9 percent.
This implies that tightening measures have not shown any meaningful results. The fiscal deficit stood at 2.5 percent in 4QFY8 while the deficit was 2.1 percent in 3QFY18 and cumulatively it was 2.2 percent in 1HFY18. The equation is simple; in order to cut down the imports growth, in addition to tightening measures, fiscal deficit has to be reigned.
The story of inflation is not much encouraging either, as the IBA-SBP surveys show that inflationary expectations are building up. The CPI crossed 5 percent in June18; and the SBP expects CPI to be higher than FY19 target of 6 percent. To bring the inflation back within target, and to curtail the aggregate demand, expect more tightening in the upcoming reviews.