As expected the central bank on Friday slashed its discount rate by 50 basis points to 10 percent from 10.5 percent for the next couple of months. The regulator, however, urged the government to take “comprehensive” fiscal reforms, keep its budgetary borings from it in check and avoid the negative consequences of excessive borrowings from the scheduled banks. The central bank also proposed an effective overhaul of the governance structure of the energy sector that, it believes, is important for the revival of private credit, investment and sustainable medium to long term economic growth. To take effect from the 8th of this month, the rate-cut was decided by the Central Board of Directors of the State Bank of Pakistan (SBP) at its meeting held here at SBP with SBP Governor Yaseen Anwar in chair.
A continued deletion in the inflation rate that contracted in September to single digit, 8.8 percent happens to be the major attributable factor in the 50bps rate-cut. “A consistent deceleration in inflation since May 2012, to 8.8 percent in September 2012, is more than earlier estimates. Thus, despite an expected uptick in H2-FY13, the overall inflation outlook has improved. In fact, the likelihood of meeting the 9.5 percent inflation target for FY13 has increased,” the SBP said. At the macro level, it said, it seems that the effect on inflation of falling private investment demand was becoming more pronounced than the influence of high fiscal borrowings. “The disaggregate CPI inflation data also show that this could be a beginning of a broad based trend. The number of commodities with double digit year-on-year inflation has slightly come down in the last few months after a secular increase over the last three years; first in the food group and now in the non food group as well.” The decline in 20 percent trimmed core inflation measure, to 10.4 percent in September, is slower than the fall in CPI inflation. “This indicates persistence of inflation expectations due to inertial effect of high inflation experienced in the recent past, overall rising trend in fiscal borrowings from the SBP, and depreciation of exchange rate,” it said. The regulator said the recent fall in inflation together with a retirement of Rs412 billion of fiscal borrowings from SBP during Q1-FY13 could bring down core inflation further by having a beneficial impact on inflation expectations. This would depend, however, on the fiscal authority’s resolve to maintain this trend in the coming quarters, the bank warned. While discussing the previous rate cut announced in August 2012, the Monetary Policy said that a declining inflation together with weak growth in credit to private businesses was the basic context in which SBP reduced its policy rate by 150 bps in August 2012. “The resumption of monetary easing, in this environment, was deemed necessary to influence the behavior of borrowers in the private sector and scheduled banks to step up efforts to improve their intermediary role,” the SBP said adding a host of factors needs to be considered for this to be sufficiently effective. “Prominent among these are considerable improvement in the availability of energy and reduction in fiscal borrowing needs from the banking system. The former is expected to facilitate an increase in the demand for credit and the latter would help in improving the supply of credit to the private sector.” Further support to SBP’s initiative can come from realization of expected foreign financial inflows that would alleviate the balance of payment concerns and help in easing the considerable fiscal pressure on domestic borrowings, the bank added. “The effectiveness of SBP’s current monetary policy stance continues to weigh upon improvement in the fiscal position, better availability of energy, and an increase in foreign financial inflows,” it said. The central bank pointed out that weak foreign financial inflows are the main challenge faced by the balance of payment position. “The external current account balance, on the other hand, is small and shrinking. In fact, during the first two months of FY13, it posted a surplus of $884 million. This is primarily due to robust growth in remittances, $2.5 billion received in July and August 2012, and receipt of $1.12 billion Coalition Support Funds in August 2012,” it said. According to SBP, the constrained by energy shortages and weak global economy, the export growth remained subdued. The import growth has also slowed down and most of the incremental increase over the corresponding period of last year is because of price impact, it observed. The retirement of government borrowings to SBP was made possible by substantial borrowings from the scheduled banks; Rs437 billion during 1 July–21 September FY13, it said adding that consequently, the outstanding amount of liquidity injections by the SBP has increased to Rs611.5 billion by the end of Q1-FY13.
“While this may not be an optimal situation, it is necessary in current circumstances. This is because some base money creation is essential to avoid an economic depression. The creation of money through the other source, accumulation in the Net Foreign Assets (NFA) of the banking system, is difficult due to weak foreign financial inflows. Similarly, the SBP (Amendment) Act (2012) requires at least zero net flow of fiscal borrowings from SBP during a year,” the bank observed. To continue to keep borrowings from SBP under check and avoid the negative consequences of excessive borrowings from the scheduled banks, comprehensive fiscal reforms should not be delayed further. “These include, but are not limited to, broadening of the tax base, reduction in wasteful subsidies and better coordination between federal and provincial governments in terms of keeping the consolidated fiscal position under control,” said the SBP.
