Forward steering efficiency
Forward guidance is a global practice of central banks, which provides information about their future monetary policy “intentions”. These forward-looking indications are based on a detailed assessment of trade, inflation and balance of payments, foreign exchange reserves and redemptions, etc.
When a central bank gives its forward guidance, it must be credible and consistent for the markets and the economy. Therefore, not only does it need to be tracked by central bank actions, but how it is communicated is also important as it is supposed to help market participants make decisions as well.
For example, if a central bank reveals that it will pursue an accommodative monetary policy and that interest rates are likely to stay low for the foreseeable future, businesses and individuals will make their investment or spending decisions accordingly. These clear directions will also bring stability to markets and / or prices.
Pakistan’s central bank also continued this practice of “forward guidance”. The trend is encouraging; however, it appears that either the content of the State Bank of Pakistan’s forward guidance is “ambiguous” or not “communicated” effectively to the markets, as the underlying uncertainties in the markets continue to resurface. and deteriorated feelings.
This uncertainty has an impact on Pakistan’s macroeconomic stability. Here you have to ask yourself, what went wrong?
This article aims to highlight the shortcomings of SBP Forward Guidance and share an opinion on why clarity is needed in central bank forward guidance to calm markets and deal with lingering uncertainties.
SBP deviated from its political intention on November 19, 2021 contrary to what was revealed in the Monetary Policy Statement (MPS) of July 27, 2021 and September 20, 2021.
Let us briefly recap what happened on July 27, 2021. According to the “forward guidance” of the SBP in its MPS of July 27, 2021;
“The Monetary Policy Committee (MPC) expects monetary policy to remain accommodative in the near term, and any policy rate adjustment to be measured and incremental to achieve slightly positive real interest rates over time. If signs emerge of demand-induced inflationary pressures or current account vulnerabilities, the MPC noted that it would be prudent for monetary policy to begin to normalize through a gradual reduction in the degree of accommodation.
The policy rate remained unchanged at 7 percent mainly due to; a) continued national economic recovery; and b) improved inflation outlook. SBP forecast that GDP growth will remain at 4-5% in FY22. Imports are expected to increase, but resilience of exports and remittances increases the DAC, which will remain in a range of 2 to 3 % of GDP in fiscal 22 (the Canadian dollar was lower than in fiscal 18 and 17). Foreign exchange reserves are expected to improve with an adequate availability of external financing of $ 20 billion.
According to SBP’s forward-looking indications in MPS of September 20, 2021, it is below;
Looking ahead, absent any unforeseen circumstances, the MPC expects monetary policy to remain accommodative in the near term, with a possible gradual reduction in stimulus measures to achieve slightly positive real interest rates in the near term. over time.
The policy rate rose 25 basis points to 7.25% on September 20, 2021. SBP believed that ongoing economic growth has exceeded expectations, mainly due to a strong domestic recovery coupled with international prices oil, which could lead to a strong selection of imports and lead to a rise in prices. GOUJAT.
SBP was signaling to markets in both cases that despite the overheating Pakistani economy, this; a) ongoing monetary tightening will be gradual; and b) policy measures will remain broadly accommodative in the short term.
Interestingly, the policy rate suddenly jumped 150 basis points from 7.25% to 8.75% on November 19, 2021, which was contrary to previously given indications. After raising the policy rate by 150 basis points, the next business day, the International Monetary Fund (IMF) issued its long-awaited press release on the critical talks between Pakistan and the IMF for the 6th review and welcomed the Pakistan’s economic progress.
On the other hand, policymakers have taken several measures to limit the current overheating of the economy. This includes a) increasing the average required liquidity reserve (CRR) of programmed banks from 5% to 6% (maintained for a period of two weeks) and the daily maintenance limit of the CRR increased from 3% to 4 % b) tighter self-financing c) impose limits on the outflow of dollars and biometric evidence for purchases of $ 500 or more and c) increase margin limits by 100 percent on imports.
At this point, the Pakistani authorities and the IMF have had several policy-level discussions on the 6th review under the EFF (Extended Fund Program) implementing prior actions for subsequent versions. This has already had a negative impact on the stock market, the exchange rate and led to high imports / CAD. SBP has already tightened the screws to remove the overheating and underlying demand from the economy.
Pakistan’s strong import growth of around 70 percent compared to 25 percent of exports in fiscal year July-November 22, widened the trade deficit to alarming levels of $ 20.64 billion, affecting the harder the current account deficit and increased imported inflation. This must have been limited by the Ministry of Finance, but it seems that they could not read the “pitch” well. As a result, the markets were negatively affected, creating an unnecessary “political imbalance”.
At this point, the SBP raised its key rate by 150 basis points to appease the last lender so that the program can resume. This was a departure from its forward-looking stance taken in July 2021. In addition, the SBP has aggressively pursued monetary tightening to counter inflationary pressures at the expense of economic growth. There should be a balance between the two for economic sustainability.
In addition to this, the frequency of monetary policies also increased from six to eight. It also helped fuel the lingering uncertainty in Pakistan’s stock, money and foreign exchange markets. This could have been part of the forward guidance in July 2021, when the markets were relatively stable. However, this political insertion was made when uncertainty had risen due to IMF program delays, aggressive monetary tightening and strong import growth, which deteriorated the CAD and was reflected in falling exchange rate. In anticipation of a further hike in monetary policy, banks made a higher bid when auctioning Treasury bills on December 1, 2021. The yield on three-month Treasury bills appreciated 228 points. base at 10.78%, which is 203 basis points above the key rate. SBP’s MPC said in a political statement that “this increase seemed unwarranted”
Nonetheless, aftershocks continued to fuel negative sentiment and, as expected, the SBP raised its policy rate by 100 basis points to 9.75% on December 14, 2021. This rate changed within 18 business days, the SBP adjusting its position by declaring “the final objective of slightly positive real interest rates on a forward-looking basis was now close to being reached and the key rate would remain broadly unchanged in the short term”.
The SBP report showed that the yield on three-month treasury bills remained absolutely stable at 10.78% on December 15, 2021. The stake was skewed in favor of short-term papers, implying that the market is anticipating a fall. further hike in the key rate.
This prompted SBP to opt for a rare move. He conducted two reverse open market (OMO) operations for 63 days in one week at 9.9% and 9.85% to calm the markets and deal with the lingering uncertainty. So far, the amount accepted in 63 days exceeds one trillion rupees. Secondary market returns are always below a 10.78 percent three-month threshold return. This would adjust the market overreaction to interest rates and bring calm. Following forward guidance from the SBP, the monetary policy rate was expected to remain unchanged in January 2022. This signaled to the markets that the SBP is ready to take on the banks. But the damage is already done.
In order to cope with persistent volatility and uncertainty in the markets and future inflationary expectations, the SBP must first review the content of its forward guidance to make its monetary policy more prudent, transparent and efficient, and also ensure that it is well communicated to the markets. Second, coordinated and coherent monetary and fiscal policy actions are needed, with the broader objective of price stability and growth.
The writer is a freelance columnist