The State Bank of Pakistan (SBP) has slashed discount rate by 150 bps to 10.5 percent for a period of two months, a very surprising and welcome decision for industrialists and business community in the country.
The cut in policy rate was announced by SBP Governor Yaseen Anwar on Friday. The decision was made in the light of controlled inflation that came down to 9.6% in July, while the incentive aimed at giving the private sector a chance to enhance investment for sustainable economic growth.
The reduction in interest rate is likely to stimulate the economy of the country as credit to private sector is expected to increase to grow the business activities in the country. The role of central bank is not to control finance of the country but it also invigorates the economic activity in the country, Anwar added. The receipts of $1.118 billion from US have given cushion to current account, on the other hand, remittance played a vital role in the stability of external account, he further said.
He said that the economy seems to have settled at an unenviable equilibrium of high inflation and low growth. The protracted energy crisis and weak fiscal fundamentals are the main reasons behind this outcome.
Similarly, the declining trend in private investment expenditures is continuing while strength of the balance of payment position remains contingent upon foreign financial inflows.
The pace of increase in domestic debt is also considerable and uncertain global economic conditions in the Eurozone and the US do not inspire much confidence either.
According to the SBP governor, “The average CPI inflation for fiscal year 12, at 11 percent, was well within the target of 12 percent for the year and on the lower side of SBP’s earlier projections.”
He stated that the main reason for this moderation in inflation is a collapse in real private investment, indicating a structurally weak economy. However, it continues to persist in double digits. This persistence is primarily due to entrenched expectations of inflation remaining high. It seems that key drivers for this expectation are continued fiscal borrowings from the SBP despite legal restrictions and feared depreciation of exchange rate even with a modest external current account deficit. “
He asked that more recently, the year-on-year inflation has declined to 9.6 percent in July 2012 from 12.3 percent in May 2012. An unanticipated fall in international oil prices in May and June and a huge reduction of 50 percent in the administered prices of gas in early July 2012 are mainly responsible for this deceleration. The former has already proved to be temporary as the international oil prices have increased since then. The effects of the latter may also only have transitory effects for a few months. Nevertheless, the decline in inflation in July 2012 has created strong market expectations for a downward revision in SBP’s policy rate. There has been a noticeable reduction in yields on the government securities in the secondary market and KIBOR. In any case, it would be too early to call it an emerging trend as there are still deep-rooted factors driving inflation. Stickiness in both the core inflation measures points towards the persistence of inflation in low double digits. SBP projects average CPI inflation for fiscal year 13 to remain in the range of 10 to 11 percent, which is higher than the announced target of 9.5 percent for fiscal year 13. However, much would depend on fiscal restraint on borrowings from SBP, realization of estimated foreign financial inflows, and improvement in energy shortages to increase the utilization of installed capacity.
Anwar said the provisional National Income Accounts estimates show that real GDP growth of 3.7 percent in fiscal year 12 was primarily driven by consumption expenditures. Total investment and exports of goods and non-factor services show a significant contraction. The contraction in private investment, for the fourth consecutive year, at 13 percent is particularly of concern. The total investment, as a percentage of GDP, has fallen to 12.5 percent in fiscal year 12, which does not bode well for the future productive capacity of the economy.
For generating sustainable economic growth in the medium term, it is important to stem further decline in investment.
Similarly, given the fragile global economic conditions, an export-led growth also looks less likely to take place. Incorporating these considerations, SBP projects growth in real GDP for fiscal year 13 to remain between 3 and 4 percent; well below the target for the year and the country’s economic potential. To revive economic growth, the focus must be on an endogenous reform process that focuses on improving infrastructure, productivity, and governance. The utilization of credit by private businesses is one of the important ingredients of investment. However, the net flow of credit to Private Sector Businesses (PSB) was a meager Rs 18.3 billion in fiscal year 12, which is a drastic decline compared to a net flow of Rs 173.2 billion in fiscal year 11.
Not only the amount disbursed to PSBs was small but the retirements from them were also unusually high. Further, a disaggregated assessment shows that a large part of total credit extended to the private sector was in fact availed by the Non-bank Finance Companies (NBFCs). The main factors that have significantly dampened the demand for credit by private sector businesses are persistent electricity and gas shortages, security conditions, and a challenging political environment. In these circumstances, businesses are avoiding significant commitments in terms of expansion and long term investments. At the same time, scheduled banks continue to prefer government over the private sector. This is despite an improvement in the currency to deposit ratio and a considerable deceleration in growth of Non Performing Loans (NPLs). Given the desired expansion in the private sector credit and the growing need of the public sector to borrow from the banking system, a consistent increase in deposits and improvement in overall financial depth is imperative.
The growth in both reserve money and broad money (M2) in fiscal year 12 was primarily driven by fiscal borrowings for budgetary support. Of the total expansion of Rs 223 billion in reserve money, Rs 505 billion was due to direct fiscal borrowings from the SBP. The difference is largely due to a significant contraction of Rs 225 billion in the Net Foreign Asset (NFA) of the SBP. Also, the pace of these borrowings increased significantly in the second half of fiscal year 12, with Rs 306 billion borrowed in the fourth quarter alone. Not surprisingly, the provision of liquidity in the market by the SBP came down considerably in the fourth quarter as well.
The SBP governor said these borrowings are despite commitments announced in the fiscal year 12 budget, re-assurances made during the year, and more importantly, requirements of the SBP Act.
In particular, the act states that the fiscal authority not only has to ensure no further accumulation of their debt owed to the SBP but also take steps to retire their borrowings from SBP over the course of next seven years.
The fiscal borrowings from the scheduled banks grew by 50 percent in fiscal year 12 and contributed 67 percent to the overall increase of 14.1 percent in M2.
Apart from crowding out the private sector, these substantial and, at times, unpredictable fiscal borrowings created substantial challenges for monetary management. For instance, short term market interest rates remained volatile and on average on the higher side, imparting inertia to other market interest rates. As a result, the decline in lending rates for the private sector, after a 200 basis point reduction in the policy rate in the first half of fiscal year 12, has been less than desirable.
