Sometimes, the cure seems more painful than the disease.
Most business analysts are betting the Monetary Board (MB) will raise policy rates this week, reversing a two-year trend. The trend was caused by more benign inflation – until Trump turned our world upside down.
Since the US-Israeli attack on Iran Feb. 28, oil prices spiked. This translated into higher transport cost across the board. Inevitably, more expensive fuel will have second round effects on every commodity in the market, creating a surge in the inflation rate. March inflation was tracked at over four percent – much higher than projected before war broke out in the Middle East.
The expectation is that the MB will raise interest rates by a quarter of a percentage point. This will bring up the benchmark rate to 4.5 percent.
The increased rate might seem vastly less dramatic than all the events holding world attention for the past six weeks. It will certainly not suffice to hold back the inflation surge we are experiencing. But it is definitely a clear signal to the market.
By tightening spending, the MB hopes to discourage discretionary spending. This includes, unfortunately, not only household expenditure but also capital outlay. Higher interest rates have the effect of slowing down economic expansion.
A higher policy rate, albeit marginal, will help reinforce the peso’s exchange rate. All the havoc caused by the war on Iran forced the peso lower. A cheaper peso magnifies the cost of imported energy, which is denominated in hard currencies.
Since the war began, the peso slid to below $1:P60 – an exchange rate of great psychological significance. Although the peso’s depreciation was expected, given our weak fiscal management and propensity to incur public debt, the fallout from war in the Middle East hastened the weakening.
All things considered, the weaker peso is the new normal. We are not about to see our currency’s resurgence. Not with our debt pile. Not with the prospect of diminished remittance flows. Not with our dependence on imports.
Economists love to remind us that a softer peso will be good for families dependent on remittances – except that many of our workers in the Gulf states are facing disemployment. Dubai, in the course of this war, has become a ghost town. Its business model as a low-tax and peaceful investment sanctuary has been blasted by Iranian drones.
Economists love to remind us that a softer peso encourages our exports – except that we have virtually no exports to speak of. We have become a net importer of food. This means a lower peso exchange rate immediately feeds into the inflation surge.
But we have to raise our interest rates nonetheless. The first mandate of the MB is to keep prices as stable as possible – even as that might seem like trying to roll a rock up a hill. The first enemy of the MB is an escalating inflation rate – even as this is mainly due to cost-push from imported commodities.
The MB has the same affliction as the mythical King Canute. Like the exasperated king, it orders the tides to be still.
In the present case, the tides are global and the ripples are overpowering.
There is little indication that the elevated oil price regime we are all suffering from will abate anytime soon. A frantic Donald Trump is trying to exit the nightmare he walked all of us into. He keeps imagining a negotiated end to the war is at hand. In reality, he is still negotiating to negotiate.
The diplomatic standoff will take a lot more time. Trump never imagined he would be waging war against a proud nation that values its honor so much. A man governed by his baser instincts and unbounded narcissism cannot comprehend honor.
The blockade at the Strait of Hormuz is not going away anytime soon. Iran has learned the power of its ability to constrict movement in this narrow waterway. Tehran will use its grip on Hormuz, combined with its ability to devastate the Gulf states, as means to protect itself from murderous US-Israeli attacks.
Even if some ships could eventually traverse the strait, we are facing a huge shipping backlog. About a thousand ships have been trapped at the Persian Gulf for over six weeks now. It takes about 10 days to fill up a supertanker. It is a slow moving vessel that takes weeks to complete its journey and even more time to unload at its destination.
The most effective blockade of the Gulf, it turns out, is the refusal of insurers to absorb the risk of covering shipments through Hormuz. Trump’s dimwitted blockade at the Gulf of Oman simply magnifies the paralysis.
It will take many months to normalize the shipping issue hounding global oil supply. After that, we will have to wait for the damaged facilities to be repaired at no mean cost. The LNG production facilities damaged in Qatar will take at least five years to restore.
The last time global oil supplies were disrupted, it took the global economy a decade to return to pre-disruption levels. The disruption we see today is unprecedented. Which means restoration will require more than a decade. This is the final measure of Trump and Netanyahu’s folly.
Meanwhile, the MB will try to rein in the scourge of inflation with the puny means it has.