In its most recent monetary policy statement (MPS), released on September 16 by State Bank of Pakistan (SBP), the policy rate has been kept unchanged at 11 percent due to fears of build-up of inflationary pressures in the wake of floods.

The MPS has apparently based its decision on a contradiction, where on one hand it acknowledges that ‘This temporary yet significant flood-induced supply shock, particularly to the crop sector, may push up headline inflation…’, which means that inflation would likely rise mainly due to flood-induced aggregate supply shock while, on the other, links this inflationary pressure with interest rate, as if it were a demand-driven inflationary pressure, which it clearly is not.

Also, the statement notes, among other things ‘...moderately growing domestic demand…’, which is likely to further slow down due to large-scale devastation of mainly farm economy due to catastrophic flooding; where aggregate demand had already seen a lot of squeezing at the back of around three years of monetary tightening (or monetary austerity).

Reduced aggregate demand has also evidenced from overall medium-term low economic growth equilibrium on average – roughly around the population growth rate — and dramatically increasing levels of unemployment — and poverty levels, and most likely there would also have been significant rise in inequality, given real economy has fared lot less favourably than those earning interest payments.

Hence, real interest rate is still at a whopping 8 percent, and dividends from a narrowly-based stock exchange market have, in turn, received a lot of investment from these interest rate-based earnings.

On the other hand, lack of economic reforms, and needed incentivization has not attracted any significant amount of investment into the real sector as evidenced, for instance, from an overall medium-term paltry performance........

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