Monetary Policy --- How high can you fly with broken wings?

Monetary Policy --- How high can you fly with broken wings?
So, what is your call today? I had inquired this to a colleague; said, “If SBP hold rates this time around, I would question its autonomous”

Many would argue what rate decision has to do with central bank’s independence? To answer this one need to understand our economy. In our daily life you must have observed that when demand increases prices follows. This daily life observation goes well for any country. Price increase more than expectations is a problem. This problem can be tackled by either increasing supply or by curtailing demand. Supply can be increase by producing more or through imports. In our case, the former is difficult due to capacity constrains and later requires GREENS. One may argue for increasing production capacity. Well, that can be done through investments but government heavy reliance on banking sector is clotting liquidity for a heart attack, which threatens our financial stability and it also crowd out private sector. If this gap is bridge by increasing imports rupee will depreciate and jack up inflation. So, the only available option was to curtail aggregate demand. As this is achieved by targeting money supply therefore rates were raised. This is text book theory, which we are following at the moment. The entire world is in search of a better solution, they are molding their economic and financial models according to their situations and we will have to find one for ourselves.

But still it does not answer the question, what it has to do with central bank’s independence? In our case, curtailing demand or maintaining rupee stability was not in favor of the government. The government collects more revenue if inflation increases (these views were shared by chairman FBR during his visit to KCCI) and thus government favors lose policies, both fiscal and monetary and thus resists curtailing demand or a rate increase. SBP must have felt the pressure from the high powered meeting of Prime Minister, Ministry of Finance and CM of four provinces. But despite these pressures MPC opt for raising rates. SBP was transmitting signals for its possible policy course since March, although in the first half of FY10 SBP slashed 150bps but by March it was reversed. According to March meeting minutes, two members of MPC wanted to give the right signal to the market as well as to the fiscal authorities by increasing the policy interest rate but five voted for no change (one member was absent). I conducted a survey of 20 odd banks and brokerage houses for their rate expectations and none was anticipating increase, almost all were ignorant of March meeting minutes and May policy statement.

A few reasoned scraped PIB auction as a justification or indication for no rate change, which was again baseless as MOF decides cut offs for bill, notes and bonds, so technically, it gives no policy signal. After 50bps rate increase there were short message regarding possible impact, some read stock and bond market will fell. Off course it will amid a vital input for fair value calculation is risk free rate and if that rate is higher securities will have to adjust accordingly. Besides, foreigners are major players at present, if rate increase stables rupee, they may invest more. For real sector, it’s already difficult because of inflation (high cost of doing business). But there was one thing confusing, the latest policy statement reads, monetary policy has to take lead for containing aggregate demand pressures emanating mainly from expansionary fiscal position. This should have been like despite SBP signals government failed to adjust and thus policy rate has been increase. This would have eased a lot of pressure from the central bank.

Anyways…..after the decision I had asked my colleague, if the central bank is independent? Yes, she said.