The State Bank of Pakistan’s Monetary Policy Committee on Wednesday increased the benchmark interest rate 100 basis points, to 21 percent, in an attempt to control inflation. While the need to control inflation is indisputable, doing it by revising the interest rate does not seem to be working. At the beginning of the financial year, in June 2023, the benchmark rate was 13.75 percent. So far, it has been raised 7.25 percent by the MPC, without inflation slowing down. If anything, as the March figures indicate, it is speeding up. Part of the problem is that inflation is an intractable beast. Once it has crossed a certain level, it is almost impossible to stop. However, while some might argue that present levels of inflation are hyperinflationary or at least pre-hyperinflationary, where price rises are both rapid and huge, that stage has probably not yet been reached. It is only by taming the beast of inflation that it can be avoided.
Apart from failing to tame inflation, the rupee’s value has not been defended. It has now slipped to Rs 290 per dollar, with the psychological limit of 300 not that far ahead. Once that is breached, it is hard to predict where it will stop. A falling rupee is not what Pakistan would have liked to take into the storm that will hit after the OPEC+ members decided to cut production, and thus drive up oil prices. The belief will be strengthened that Pakistan’s inflation is imported, and not to be tackled by monetary policy alone. All the present increase will achieve is to push more enterprises towards default, as the gap between the interest rate they assumed, and the actual rate, becomes too large for them to sustain.
If not monetary, what other tools does the government or the SBP have? The MPC was clearly hedging its bets, as it said that the monetary tightening would bring about the achieving inflation targets, though that assessment was threatened by domestic political uncertainty and global financial conditions. So can anything be done? And if so, what? The Minimum Reserve Ratio can be increased, to mop up liquidity, something last done in November 2021. The subsidy for petrol targeted the poor, but a subsidy scheme for essentials, paid to producers, and aimed at eliminating inventories, is also a possibility. However, another anti-inflation tool, reduction of government expenditure is already being tried. The almost ritual cut in development expenditure has already been made. An inflow of a few billion dollars would help, but the IMF programme’s resumption is still doubtful.
