ajpirzada
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Misplaced optimism surrounds monetary policy review
THE latest monetary policy announced has moved in the right direction. The policy rate has been reduced further by 0.25 basis points to 5.75pc for the next two months.
Even though year-on-year aggregate CPI-based inflation has increased from 3.9pc in March 2016 to 4.2pc in April 2016, the core inflation — non-food, non-energy YoY — has decreased from 4.7pc to 4.4pc over the same period which is also lower than the 4.5pc observed in February 2016.
Furthermore, the decline in YoY core inflation is much steeper when compared with the 5.4pc observed for the corresponding month last year (April 2015).
The strength of the BoP and consequently the SBP reserves is predominantly based on borrowings and workers’ remittances
However, the tone of the Monetary Policy Statement (MPS) is unduly optimistic. Except for ‘uncertainty may arise if there is an adverse change in oil price or workers’ remittances,’ there is almost no reference to the uncertainties surrounding the economic fundamentals. The decline in core inflation over the last two months, despite substantial increase in food and energy price inflation, points to weakening in demand pressures which were observed building up in the months following September 2015.
Even if the tone is partially justified when discussing inflation dynamics, the optimism surrounding the balance of payments (BoP) numbers can only be termed exaggerated. The current account balance has marginally improved from negative $1.85bn to negative $1.52bn over the period of July-April 2015-16. However, this apparent stability is on account of remittances and low oil prices. On the other hand, trade balance has worsened. While exports have declined across all sectors, imports, other than food and energy, have increased.
The false notion forwarded by some analysts that export receipts have declined because of decline in commodity prices, and not quantity, is not supported by data. The Pakistan Bureau of Statistics (PBS) data on ‘index numbers of quantum of exports (and imports)’ show that even the quantity of exports has fallen whereas the quantity of imports has increased.
The quantum of exports index has declined from 205 for Oct-Dec FY15 to 193 for Oct-Dec FY16. On the other hand, quantum of imports index has increased from 304 to 356 over the same period. A similar trend is seen across all quarters since FY14. This is consistent with the explanation that the trade balance has worsened due to the appreciation of real effective exchange rate during the last two years and the sluggish international trade.
The net income outflows – mostly made up of interest payments on loans — have also increased by $171m over the period of July-April FY16. More importantly, other investment liabilities, which include international borrowing, have increased from $0.59bn in July-April FY15 to $1.97bn in July-April FY16. Consequently, net income outflows are more likely to increase in the future.
The marginal increase of $109m in net FDI is solely due to increase in the Chinese investment. FDI from the US and the UK has declined substantially. This leaves the foreign direct investment side of the BoP at the mercy of CPEC projects.
Taken together, the strength of the BoP and consequently the SBP reserves is predominantly based on international borrowings and workers’ remittances. Large-scale international borrowing, though useful in averting currency crisis, essentially keeps the domestic currency artificially overvalued thus discouraging exports.
In the absence of substantial improvement in trade balance and net FDI, BoP is vulnerable to worsening of Gulf economies which are currently struggling in the face of persistently low oil prices. The growth rate of future remittances may decline. Professor Carmen Reinhart of Harvard’s Kennedy School notes that commodity price cycles are much longer than business cycles with booms and busts lasting for 7-8 years each (on average).
The BoP is also expected to come under increasing pressure as outstanding external loan matures and more so if oil prices also start to increase (less likely given weak state of global economy). Yet the MPS makes no mention of these fundamental weaknesses.
Moreover, two of the three reasons mentioned for higher expected inflation in FY17 are essentially supply side shocks including possible increase in global oil prices and ‘imposition of new taxation measures and increase in electricity and gas tariffs.’ None of these are good news for the economy. Importantly, the economy will return to low inflation levels once the effect of these expected shocks die out.
The MPS rightly observes optimism about ‘recovery in large-scale manufacturing.’ Improvement in energy supplies during the second half of this fiscal year has helped the LSM to register a ‘4.7pc growth rate during July-March FY16 compared to 2.8pc in July-March FY15.’ It is only reasonable to expect the LSM growth rate to increase ‘further on account of improving energy and security conditions.’
THE latest monetary policy announced has moved in the right direction. The policy rate has been reduced further by 0.25 basis points to 5.75pc for the next two months.
Even though year-on-year aggregate CPI-based inflation has increased from 3.9pc in March 2016 to 4.2pc in April 2016, the core inflation — non-food, non-energy YoY — has decreased from 4.7pc to 4.4pc over the same period which is also lower than the 4.5pc observed in February 2016.
Furthermore, the decline in YoY core inflation is much steeper when compared with the 5.4pc observed for the corresponding month last year (April 2015).
The strength of the BoP and consequently the SBP reserves is predominantly based on borrowings and workers’ remittances
However, the tone of the Monetary Policy Statement (MPS) is unduly optimistic. Except for ‘uncertainty may arise if there is an adverse change in oil price or workers’ remittances,’ there is almost no reference to the uncertainties surrounding the economic fundamentals. The decline in core inflation over the last two months, despite substantial increase in food and energy price inflation, points to weakening in demand pressures which were observed building up in the months following September 2015.
Even if the tone is partially justified when discussing inflation dynamics, the optimism surrounding the balance of payments (BoP) numbers can only be termed exaggerated. The current account balance has marginally improved from negative $1.85bn to negative $1.52bn over the period of July-April 2015-16. However, this apparent stability is on account of remittances and low oil prices. On the other hand, trade balance has worsened. While exports have declined across all sectors, imports, other than food and energy, have increased.
The false notion forwarded by some analysts that export receipts have declined because of decline in commodity prices, and not quantity, is not supported by data. The Pakistan Bureau of Statistics (PBS) data on ‘index numbers of quantum of exports (and imports)’ show that even the quantity of exports has fallen whereas the quantity of imports has increased.
The quantum of exports index has declined from 205 for Oct-Dec FY15 to 193 for Oct-Dec FY16. On the other hand, quantum of imports index has increased from 304 to 356 over the same period. A similar trend is seen across all quarters since FY14. This is consistent with the explanation that the trade balance has worsened due to the appreciation of real effective exchange rate during the last two years and the sluggish international trade.
The net income outflows – mostly made up of interest payments on loans — have also increased by $171m over the period of July-April FY16. More importantly, other investment liabilities, which include international borrowing, have increased from $0.59bn in July-April FY15 to $1.97bn in July-April FY16. Consequently, net income outflows are more likely to increase in the future.
The marginal increase of $109m in net FDI is solely due to increase in the Chinese investment. FDI from the US and the UK has declined substantially. This leaves the foreign direct investment side of the BoP at the mercy of CPEC projects.
Taken together, the strength of the BoP and consequently the SBP reserves is predominantly based on international borrowings and workers’ remittances. Large-scale international borrowing, though useful in averting currency crisis, essentially keeps the domestic currency artificially overvalued thus discouraging exports.
In the absence of substantial improvement in trade balance and net FDI, BoP is vulnerable to worsening of Gulf economies which are currently struggling in the face of persistently low oil prices. The growth rate of future remittances may decline. Professor Carmen Reinhart of Harvard’s Kennedy School notes that commodity price cycles are much longer than business cycles with booms and busts lasting for 7-8 years each (on average).
The BoP is also expected to come under increasing pressure as outstanding external loan matures and more so if oil prices also start to increase (less likely given weak state of global economy). Yet the MPS makes no mention of these fundamental weaknesses.
Moreover, two of the three reasons mentioned for higher expected inflation in FY17 are essentially supply side shocks including possible increase in global oil prices and ‘imposition of new taxation measures and increase in electricity and gas tariffs.’ None of these are good news for the economy. Importantly, the economy will return to low inflation levels once the effect of these expected shocks die out.
The MPS rightly observes optimism about ‘recovery in large-scale manufacturing.’ Improvement in energy supplies during the second half of this fiscal year has helped the LSM to register a ‘4.7pc growth rate during July-March FY16 compared to 2.8pc in July-March FY15.’ It is only reasonable to expect the LSM growth rate to increase ‘further on account of improving energy and security conditions.’
