SBP puts its wallet on the table and points towards the Parliament

The State Bank of Pakistan (SBP) tends to refer the cash-strapped federal government to the Parliament if the latter failed to meet the legal requirement of zero quarterly borrowings from it as provided in the State Bank of Pakistan (Amendment) Act (2012).
Friday saw SBP’s Central Board of Directors issuing its Monetary Policy Statement for next two months of FY12.
Keeping the discount rate unchanged at 12 percent, the bank decided to raise the minimum profit rate on Rs saving/PLS saving products from 5.0 to 6.0 percent. From May 1st (2012), the banks would be required to pay a minimum profit rate of 6.0 percent on their saving/PLS saving products maintained in Pak rupee. “It was the expectation of SBP that these deposits will respond to market forces and adjust accordingly,” the bank said.
Also, the regulator raised a serious question about the revival in private sector credit and growth prospects in the country wondering that how would the funds-starved government rollover its maturing short-term debt and raise additional financing while simultaneously retiring its borrowings from the SBP?
It reminded the government of the State Bank of Pakistan (Amendment) Act (2012) that requires the former to repay its borrowing from the SBP at the end of each quarter and the existing stock was to be retired within eight years.
“In case of not observing these provisions, the Act also stipulates that the federal government will submit a statement to the Parliament giving detailed justification,” the SBP said.
Seeing more inflationary borrowings from the State Bank as a “most likely avenue” for the government given shortfalls in external sources, the central bank warned that adherence to this very legal requirement, without serious adjustment in the fiscal position, would lead to significant injections of liquidity by the SBP to keep the payment system functioning and financial markets stable.
The government borrowed Rs 373 billion from the scheduled banks and Rs 218 billion from the SBP during July–March 30 (FY12), marking a growth of 56.5 percent and 18.5 percent, respectively.
The private sector credit, on the other hand, could grow by only 4.2 percent and that in total deposits of the banking system was 17.4 percent.
“The banks continue to prefer financing the fiscal deficit as opposed to searching avenues, taking risk, and building partnerships to facilitate credit to the private sector,” the SBP noted with concern.
The SBP, it said, was already injecting substantial short-term liquidity in the system, Rs 200 billion as of 13 April 2012, which was being continuously rolled over.
Thus, simultaneously meeting the legal requirement of zero quarterly borrowings from SBP, scaling back liquidity injections, effectively anchoring inflation expectations, and creating space for the private sector, could prove to be a much more difficult task than appreciated, it added.
The State Bank warned that not all challenges currently facing the country could be tackled by the monetary policy alone. A supporting fiscal strategy and an active economic reform agenda was critical to deal with some of the structural issues, in particular, low tax to GDP ratio and energy shortages, the central bank proposed.
“The economy needs a forward-looking approach to policymaking with strict adherence to rules laid out in the legal frameworks, be it the State Bank of Pakistan (Amendment) Act (2012) or Fiscal Responsibility and Debt Limitation (FRDL) Act (2005),” it added.
The bank said its primary consideration was to bring further down inflation which it said, like last few years, would remain in double digits in FY13. “Consistently growing government borrowing requirement from the banking system is a key variable that is adversely affecting the inflation outlook,” it said adding weak private demand, on the other hand, was one reason why inflation was not increasing sharply.
Elevated international oil prices, weak quantum of exports and insufficient foreign financial flows require careful management of the external position.
“Last but not least, the consistent decline in private investment is also an important factor in formulating the monetary policy strategy as it impacts both the medium term inflation, growth and employment prospects,” said the regulator.
Following this approach is crucial in anchoring inflation expectations around the medium term targets of 9.5 percent for FY13 and 8 percent for FY14 as envisaged in the Medium Term Budgetary Framework (MTBF) of the government.
Another risk factor that, the SBP said, needed close monitoring for assessing inflationary pressures was the behaviour of international oil prices.
Government borrowing requirements are not the only source of liquidity pressures. With a gradually rising external current account deficit and consistently declining foreign inflows, the SBP’s foreign exchange reserves are on a declining path.
During the first eight months of FY12, the external current account deficit was $3 billion while the net capital and financial account receipts were only $187 million.
The SBP’s dollar reserves declined to $11.8 billion by end-March 2012 from $14.8 billion at end-June 2011.
These external sector developments are exerting downward pressure on rupee liquidity as indicated by a 21.4 percent year-on year decline in Net Foreign Assets (NFA) of the banking system by end-March 2012.
“Thus, some rupee liquidity injection and increase in reserve money is required to facilitate normal transactions taking place in the economy.”
Given substantial external debt payments, declining trend of export quantum, elevated international oil prices, and weak financial inflows, the external position the bank said was likely to remain under pressure in the remaining part of FY12 and FY13.
Predicting a “substantial slippage” compared to the revised GDP target of 4.7 percent, the SBP said as provisional financing data the fiscal deficit may have reached 4.3 percent of GDP during the first nine months of FY12.
“In terms of solutions, the economy needs deep and decisive fiscal and energy sector reforms and an early realization of planned foreign financial inflows to mitigate uncertainty,”, it suggested.
Improving financial deepening and competition in the banking system is another area of reform the regulator proposed.