SBP's MPC: Only fools rush in?

Sacrificing private sector profitability for mission creep.

Business Recorder has published a few of pieces urging SBP to increase the policy rate, even if the increase is a token increase of 25bps or 50bps. Sometimes I think SBP gets Business Recorder to prepare the ground for increasing the rates. Thankfully, the crowd that blindly supported the "hot money" attracting a discount rate of 13.25% last time has internalized the lesson that when it comes to cost-push inflation, an increase in interest rate does not have much of an impact. If there is inflation in the country, we all know it is due to an increase in the international price of commodities, devaluation of the rupee that affects imported goods.

Other than approving the amnesty for money laundering through real estate, the government has failed to take any steps to induce economic growth, much less pass any structural reforms. Rather than waiting or allowing the government to take certain steps (other than imposing price ceilings) or even publishing research recommending some steps, SBP appears to be yearning to step into the fiscal fray. It has already undertaken quite a few quasi-fiscal activities and development finance activities.

Rumor has it that the top man, yes my favorite central banker, Reza Baqir, wants to send a signal to the market by going for a token interest rate rise. The question is: what signal? How is the market supposed to interpret and respond to this signal?

We all know I don’t have much trust in SBP statistics seeing how it has been manipulated to show growth in specific sectors, but in the absence of alternatives, that is the best data we have. Moreover, on an aggregate basis, I believe the data is correct.

The below chart is made from the data in Loan Classified by Borrowers (by type of Finance).

Note that the increase in credit growth appears significant because the axis on the left doesn't start from zero. This is the default Excel chart, so I didn't play with the axis.

Loans to the private sector comprise both SBP refinancing which is are fixed-rate loans unaffected by the change in the policy rate and market-rate loans which are based on KIBOR and are affected by policy rate changes. Breaking down the loans into those two components shows the following:

From the period July 2019 to July 2021, the refinanced loans increased by 82% but from a lower base, i.e., from Rs.561 billion to Rs.1 billion. In the same period, the market rate loans only increased by 2% from Rs.4.6T to Rs.4.7T, i.e. an increase of 98 billion. (I have ignored June 2019 as banks try to manipulate the June number for their half-yearly publicly issued balance sheets).

Contrary to what Econ101 says or what Reza Baqir may try to give an impression of, we see that borrowers haven't gone crazy borrowing at the negative real rate of 7%.

The borrowers haven't increased their borrowing at all.

Personal loans, however, have been affected by the policy rate, most notably consumer car loans.

The increase in car loans (not including bank employee car loans) from June 2019 to July 2021 is Rs.99 billion, i.e., equivalent to an increase in the entire private sector (business) credit during this period.

It is sad that the consumer borrowing for splurging on imported cars is equivalent to increase in private sector (business) credit over two years.

This compels me to repeat the question that I had asked earlier.

What does SBP expect to achieve by increasing the interest rate?

Private sector borrowing is not expected to go down, as private sector borrowing is already near the floor. As the above charts have shown, increasing the discount rate to 13.25% didn't lead to any decrease in private sector borrowing though we all know that the purpose was to attract the hot money and SBP was successful in that attempt till COVID-19 struck, and the hot money rushed towards the exit.

If the objective is to reduce car financing, there are other tools available to do that, such as doubling or tripling the risk weight of car financing loans. But does SBP really want to reduce car financing? Didn't SBP launch Roshan Apni Car recently with fanfare, where those with Roshan Digital Accounts are encouraged to borrow for car financing after making a down payment of just 15%?

Moreover, as per LSM data, though its weight is small, the automobile is one of the bright lights in recent monthly data.

In the end, what is the SBP trying to achieve by increasing the policy rate? Does it want to strong-arm the GoP into doing macroeconomic reforms? Is SBP trying to play the role of fiscal managers to make it expensive for the government to borrow and thereby prevent fiscal borrowing?

I foresee the following impact of the increase in the policy rate:

  1. The federal deficit and debt servicing cost will increase as an increase in the policy rate will translate into an increase in PIB rates and NSS rates.

  2. The profitability of commercial banks will increase as they are 60-75% invested in GoP securities.

  3. GoP subsidy of Rs.36 billion on Mera Pakistan Mera Ghar will run out relatively quickly, as it is used to pay the difference between the fixed subsidized rate of mortgage and the market KIBOR spread.

  4. The profitability of the private sector will decrease due to higher financing costs.

There may be secondary impacts, but their effect will be minimal as compared to the above primary impacts. Most importantly, does SBP have any research backing that it is taking the rights steps? The graph above showed, increasing the discount rate to 13.25% had a negligible impact on private sector credit growth. It is pure mission creep on the part of SBP, which is sacrificing the private sector in favor of the fiscal side.

To conclude, any increase in the policy rate by SBP is likely to translate into the increased cost for GoP and private sector borrowers by increasing fiscal deficit and debt servicing costs without having any positive impact.

SBP needs to carry out research to show us the impact of changes in the policy rate on borrowing by GoP and the private sector, fiscal deficits, private sector profitability and the general direction of the economy. For far too long, we have been following Econ101 prescriptions when the economy is far too complex.