MONETARY POLICY TO BE ALIGNED IN SYNC WITH FISCAL POLICY AND STRUCTURAL REFORMS.

Byline: AHSAN NISAR

T he monetary policy is the key to influence trade/ current account of any country. The extent and the effectiveness of that, however, vary from country to country, given country's own political and economic dynamics and other realities on the ground. These elements must not be used as 'one-size, fits-all' as part of the template to manage the economy, particularly the external account. The effectiveness of monetary policy is already under debate these days, particularly due to the outward flight of 'hot money'. If one looks at the relationship strength between interest rate and currency in the context of Pakistan, the convention says that the relationship between these two factors shall be strong and inversely related - i.e., interest rates go up, currency stabilizes or move inversely, and vice versa.

However, in the context of Pakistan economy, the direct relationship between the two has been weak to moderate, which means that to play with interest rate to manage the currency is at best moderate but it could be safely assumed as weak looking at the relationship between the other elements of current account.

The movement of policy rate remains a strong indicator and message for the market on where the policy-makers see the economy going, but using it as a tool to manage the trade/ current account deficit remains feeble. Now, if one looks at the influence of exchange rate to manage the trade deficit, the relationship between exchange rate and exports is "strong".

However, given the fact that we have wide trade deficit and there clearly seems to be 'no relationship' between the exchange rate and the imports; therefore, there is hardly any effect of exchange rate to manage the overall trade deficit. There is weak to moderate correlation between the exchange rate and the current account deficit due to very large number of remittances, which could be impacted with the change in currency conversion rates. Given the fact, however, that our remittances are largely consumptiondriven, the flow of the currency will remain indifferent to the exchange rates, as such. Devaluation also directly results in contributing to the fiscal deficit as the cost of...