Rupee, interest rates and the economy.

Byline: Mohiuddin Aazim

Our current account deficit in July-April was $11.58 billion, down from $15.86bn a year ago. But it is still too large.

Our budget deficit in July-March was Rs1.92 trillion against Rs2.26tr for the entire 2017-18.

So the twin deficits persist. This is why the rupee remains weak and inflation is still high.

In less than 11 months of this fiscal year, the rupee has lost 24.2 per cent value against the dollar in the interbank market. Despite enough monetary tightening, yearly headline inflation stood at 8.8pc in April against just 3.7pc in April last year.

The good news is that the external-sector problems will start easing in July with the activation of a Saudi deferred oil payment facility and the finalisation of the International Monetary Fund (IMF) lending programme.

But whether inflation will also start coming down is not clear. The State Bank of Pakistan (SBP) has warned that average headline inflation for 2018-19 will range between 6.5pc and 7.5pc and that 'it is anticipated to be considerably higher in 2019-20'. The policy rate is now at an eight-year high of 12.25pc.

A large current account deficit means foreign exchange earnings are far lower than outflows. We need more dollars every month. That is, demand for the dollar keeps growing. So its price is rising and that of the rupee is depreciating. In the absence of desired growth in tax revenues, a huge fiscal deficit necessitates big government borrowing from the banking system. Since the government borrowing from the central bank i.e. printing of fresh currency notes remains exceptionally large, the supply of the rupee is growing.

Some analysts assert that ruthless monetary tightening can choke economic growth as high interest rates increase the cost of production

This enhanced supply is making the rupee cheaper. That is, inflation is on the rise. So what can the SBP do under these circumstances?

The SBP can draw on foreign exchange reserves to bridge the gap between dollar inflows and outflows. That can keep the rupee stable for a while. But its reserves at $8.06bn (on May 17) are not enough to cover even two months of imports. So it cannot draw on reserves except for a very brief period.

And what can the SBP do to check inflation? It can force the government to contain its central bank borrowing, which is highly inflationary in nature. Historically, the SBP has not been doing that though.

It cannot do so unless it gains more autonomy.

The SBP can then make...

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