IMF holds SBP responsible for high inflation

International Monetary Fund (IMF) holds State Bank of Pakistan (SBP) responsible for the persistence of a double-digit inflation in Pakistan saying the current massive liquidity injections by the central bank had inflationary impacts similar to that of the regulator’s direct financing of the budget deficit.
“The switch to government borrowing from commercial banks has been supported by large liquidity injections by SBP, a policy that has similar inflationary effects as direct central bank financing,” observed IMF in its latest country report for Pakistan. State Bank, which is currently pumping billions in the banking system with Tuesday seeing an injection of Rs37 billion only contends that these injections were imperative to avoid a possible “bank failure” in the country.
“From our perspective, if you don’t do it you have a possible bank failure,” said Governor SBP Yaseen Anwar in a recent interview with Profit. The governor said, “We have to maintain stability in the financial markets of all our banking systems. Small banks having no deposit base would suffer and will have a collapse.”
IMF, however, dubs SBP lending to finance fiscal deficits as a key driving force behind the high inflation levels in the last few years and calls for scaling back of huge money injections in the banking system and stoppage of the cash-strapped government’s budgetary borrowings. These steps, the international lending agency said, would reduce inflation and increase SBP’s policy credibility. “The authorities can help reduce the level and persistence of inflation by credibly adopting a less accommodative monetary policy stance,” it said.
Before 2008, IMF observed that 12-month Consumer Price Index (CPI) inflation had averaged about 5.5 per cent for more than a decade. In 2008, global commodity price shocked and a sharp depreciation of the rupee led to a spike in inflation, peaking at 25 per cent year-on-year in August 2008, which, although declining, remained much higher than in the pre-2008 period and higher than in neighboring countries.
It said that through domestic price subsidies, the global food and fuel price shocks were reflected in larger fiscal deficits. With external financial inflows dwindling, these deficits were increasingly financed through SBP, which put upward pressure on prices through excessive growth in SBP net domestic assets and exchange rate depreciation.
Along with the inflation level, the persistence of inflation had increased since 2008, said the fund.
“While moderate in absolute terms, persistence, which is essentially the correlation between current and lagged inflation is higher than in the regional peers,” it said, adding the increase in persistence meant that it would now take longer for inflation in Pakistan to return to its equilibrium level after a common shock hits the economy. That, IMF said, in turn implied that inflation and inflation expectations were likely to respond more sluggishly to policy changes. Referring to survey data, IMF said inflation expectations in Pakistan had continuously remained at around 15 per cent. “Persistence could be due to engrained inflationary expectations, institutional features, or CPI calculation problems,” it added.
Further, IMF warned there were risks to inflation, especially from possible supply shocks, pass–through from exchange rate depreciation, fiscal policy and continued accommodative monetary policy. Proposing remedies, the international funding institution said to slash the backbreaking price-hike the Government of Pakistan would have to undertake comprehensive fiscal reforms ensuring greater independence for the central bank. “Fiscal consolidation would free monetary policy to pursue inflation objectives,” it said adding that a more independent State Bank would be better able to resist pressures to finance the government deficit, either directly or indirectly. “And lower inflation would help the poor,” it said.