The International Monetary Fund (IMF) has predicted a significant increase in the accumulation of forex reserves of Pakistan. This will help the State Bank of Pakistan (SBP) to allow greater flexibility in the exchange rate which will lessen the vulnerabilities.
The authorities are determined in supporting the SBP to persist the spot purchasing and to fully utilise the supportive petroleum prices in order to keep on increasing the foreign exchange reserves.
Paradoxically, our current account balance is negative for the last many years which implies that Pakistan needs to borrow foreign exchange to correct the balance of payments equilibrium unless we are getting huge amounts of FDI which we are also not receiving unfortunately.
Giving all the credit to the government, Dr Asad Zaman, member of the advisory committee to the Planning Commission, said: “It is always a desirable resource to have and the government has been highly successful in building up the reserves.”
Mohammad Ali Kemal, an independent economist, responding to the IMF’s assessment said: “Building forex reserves by borrowing is not the best policy we can opt for because there is a cost of holding foreign exchange reserves.”
However, the accumulation has several other benefits and if those benefits exceed cost of accumulation then it is a good thing; although, there is no study which proves that benefits of accumulation are higher than its cost.
The IMF in its 11th review report highlighted that since the SBP reduced the policy rate by a quarter of a per cent, there is a chance of an increased moderate inflation which may accelerate higher inflationary pressures that might ultimately lead to tightening up of monetary policy.
Contradicting the IMF’s evaluation, Dr Asad stated: “Inflation has many determinants. The main reason for low inflation right now is the dramatic decline in the oil prices. Over the past five years inflation is going down and simultaneously the policy rate has also been going down. So it means that there is no empirical basis for such an estimation.”
Reduction in policy rate, if accompanied with higher credit creation will lead to inflation. Nevertheless, due to several constraints including terrorism, energy shortages and non-favourable market policies, investors are reluctant to borrow money from banks.
Additionally Kemal added that “due to higher government borrowing, banks are reluctant to lend money to the private sector at lower borrowing cost due to higher risk of repayments.”
If both scenarios continue then it may not increase inflation unless oil prices increase substantially or food prices increase substantially or some other shocks hit the economy.
Moreover, the report emphasised the government authorities to provide more strength and autonomy to the SBP which includes modifications in the SBP’s laws along with the establishment of the Independent Monetary Policy Committee and the usage of executive orders to provide a financial guarantee to the SBP in case of losses not covered by the SBP’s general reserves and recapitalise the bank if it becomes necessary and delegate to the SBP board the power to establish profit distribution rules, thereby allowing the board discretion in building reserves.
Moreover, the report, together with putting more emphasise on the transparency issues, acknowledges the publication of minutes by the MPC, on IMF’s recommendation, in order to ensure maximum transparency.
Regarding the transparency recommendations, Dr Asad said, “These recommendations have already been implemented. There is maximum transparency and the minutes are being published.”
Raising questions on the government’s implementation of transparent systems Ali Kemal said: “Autonomy and transparency on paper is different than giving operational autonomy and making it transparent in reality.”
Although these are implemented already but how meticulously it is followed will be the question of concern. For example, MPC of the Bank of England was autonomous since early 1990s and whenever inflation deviates from its target level they have to write an open letter explaining the reason for deviation.
It is worth noting that when you follow some targeted inflation then it should not deviate downward or upward from that level.