Can The MPC Rein in Pakistan's Inflation Problem?
Monetary Policy is used be many central banks to control inflation, but can the MPC body control the current inflationary environment that plagues Pakistan?
5/25/2023
Pakistan has been facing a deadly inflation spiral in the past few months decimating the purchasing power of most income groups in the country, but especially of middle- and low-income groups. Each month the inflation report points to new records being broken. However, Pakistan has been facing higher than average inflation for a number of years, including the pandemic period. The State Bank of Pakistan has a Monetary Policy Committee whose function is to read the macroeconomic environment and adjust monetary policy in such a way keep inflation under controllable and expected levels. Here we look at whether the body has been effective in doing so and whether the spiral the country is in right now can be partially corrected by adjusting monetary policy.
MPC Set Rate
The period we look at is from February 2019 to February 2023 – from a heating up economy, over the pandemic period, to the current economic and political turmoil. At the start of the period, we can observe the rates being raised by the MPC, an admission that there was persistent inflation. The rate then stayed constant, albeit at a high 13.25% for the next few meetings. The emergence of Covid enabled the MPC to reduce the rate in a short span where it stayed for roughly a year, till it began its ascent in the fall of 2021 and continues its precipitous rise.
This plays out when we look at the CPI index over the same period. Taking the 2015-16 as base we get an index value of just under 120 at the start of the period but observe an increase almost immediately, which goes on above 131 just before covid. This period coincides with then Finance Minister, Shaukat Tareen’s comment that the economy was overheated. This explains the high rate the MPC set for this period. Covid registered a decrease in the index for a 5–6-month period after which the index began its ascent, however we noted that the rate during this time stayed static. The CPI index increased rapidly till May 22, at which point it breaks the shackles, and defines the inflationary pressure the country is under.
CPI Index 15/16
The delta rate for inflation can be seen having erratic spikes during the beginning and the end of the period with less volatility in between, but still it still exhibits volatility with higher than recommended deviations. Taking this period into three phases shows the state of inflation in more detail.
Before Covid hit we get an average monthly inflation of more than 1%, indicating that we were in a high inflation environment, during the pandemic the inflation rate fell a margin, not to average levels, but still lower. Post-vaccine though inflation has been almost double the pre-covid level. There are reasons for this, the supply chain crisis, energy market slump, Ukraine war, which have exposed our economy’s structural weaknesses.
CPI Index 15/16
Average Inflation per Phase
The inverse relationship between the policy rate and inflation can be observed loosely here but we can surmise that MPC was partially able to limit the effects of inflation before the pandemic period, but structural economic rules applied at that time. The current crisis is not bound by the rules of traditional economics and represents cascading of economic woes. While the MPC has raised rates in an exponential manner in the past few months the inflationary environment has not died down and purchasing power continues to erode.
Will the recent hikes by the MPC have an effect? It is hard to say that the downturn will be due to monetary policy. It is expected that some inflation will cease but not be due to increased savings, but due to decrease in consumer expenditure. The MPC has read the market correctly and it could be argued that they acted with restraint, but the economic crisis is down to structural issues which the MPC does not have jurisdiction to address. With lack of stability in the political spectrum MPC policy has trivial effect. MPC will have a more definitive say when political stability is achieved but when that happens it is down to political and judicial stakeholders.