Friday’s monetary policy announcement for the next two months by the State Bank of Pakistan (SBP) is indicative of the market speculations that inflation is no more a major concern of the central bank while setting of the discount rate.
Two major reasons, apparently are attributed to this attitude of the regulator: A still muted demand for the private sector credit making the country’s growth prospect gloomy and lowering foreign inflows that keep haunting the economic managers on the Balance of Payment front.
Friday witnessed the SBP’s Central Board of Directors reducing the cost of bank borrowings further by 50 basis points bringing it to the single-digit, 9.5 percent, from the previous 10 percent.
To be affective from Monday, Dec 17, the new discount rate was decided by the bank’s central directors in a meeting held here with SBP Governor Yaseen Anwar.
Apparently least bothered about the “broad based decelerating” inflation that the regulator expects to average below 9.5 percent targeted for FY13, the central bank seems more concerned about the fiscal indiscipline committed unabated by the “fiscal authority”, contracting private sector credit, declining foreign inflows and substantial debt repayments to the IMF.
Last two of the negatives have exerted so much pressure on the rupee that the local currency nowadays is touching the lowest ebbs against a dollar. Friday saw the rupee trading at 98.4, lowest in country’s history, against the greenback.
Snubbing the cash-strapped government for violating the fiscal discipline by borrowing exclusively from the central bank during whole of the second quarter of FY13, the State Bank reminded the government of the recent changes in the SBP Act that requires the “fiscal authority” to ensure at least zero borrowings from the SBP during a quarter. “Given that only two weeks remain before the end of Q2-FY13, it seems unlikely that this requirement would be met,” the bank said.
According to SBP, the government’s fiscal borrowings from the banking system rose to 26.4 percent, YoY, leading to a monetary expansion of 17.8 percent.
During 1 July–November 30, the government borrowed Rs 586 billion from the scheduled banks and retired Rs106 billion to the SBP.
“Consequently, the level of outstanding liquidity injections by the SBP, at Rs 615 billion as on 14 December 2012, remains high,” said the bank adding that “These fiscal borrowings from the banking system continue to remain the main source of monetary expansion.”
About private sector credit, the bank noted with concern that the credit extended to the private businesses remained “muted” despite a cumulative 4 percent rate-cut over the last 16 months.
“The state of credit to private businesses is not encouraging and the first four months of FY13 had seen a decline of Rs 40 billion in banks’ credit to the private sector. Most of the contraction took place in the manufacturing sector.
“The reason… is that the expected support to the SBP’s initiative in the shape of improvement in the availability of energy and reduction in fiscal borrowing needs has not come through yet,” the bank said.
The regulator, however, is upbeat that the lower interest rate could potentially boost demand for credit, including that of imports, and return on the rupee-denominated assets relative to foreign currency assets.
About the external account, the bank said though the Current Account deficit in October 2012 was small, the overall stress in the external position was increasing due to declining financial inflows and substantial debt repayments.
Led by direct and portfolio investment flows, the total net capital and financial account inflows had shrunk from a peak of 7.2 percent of GDP in FY07 to 0.7 percent of GDP in FY12. “This trend is continuing in FY13,” it said.
During the first four months, there has been a net outflow of $ 304 million from the capital and financial account.
“This, together with substantial debt repayments to the IMF, has resulted in a decline in foreign exchange reserves of SBP from $10.8 billion at end-June 2012 to $8.6 billion as on 14 December 2012m” said the SBP.
Thus, despite a current account surplus of $258 million during July-October, there has been some pressure on the rupee to depreciate. Since the beginning of FY13, the rupee versus the dollar depreciated by 3.3 percent.
“This stressed external position has implications for the rest of the economy,” the State Bank warned. It said the decline in dollar reserves was causing contraction in rupee liquidity.
A depreciating currency is also affecting the size of the outstanding external debt in rupee terms.
Therefore, the SBP suggested the magnitude and speed of pass through of exchange rate changes to CPI inflation needed to be monitored closely in these circumstances.
The bank, however, said a timely realization of budgeted foreign inflows were critical for managing the Balance of Payment position.
The expected budgeted foreign inflows, the bank said, were not linked with the interest rate but could boost the much-needed financial inflows.
“The timely realization of these official inflows is of essence and can alleviate the fiscal pressure on domestic borrowings to some extent,” it added.
Giving remedies, the state bank said for the government to reduce budgetary borrowings “comprehensive fiscal reforms” were needed.
“The fiscal deficit of Rs284 billion or 1.2 percent of GDP during Q1-FY13 was entirely financed by borrowings from the domestic sources,” the bank said.
Also, the SBP said the government would find it difficult to contain the ever-burgeoning fiscal deficit without improving its tax collection capability.
Summing up, the SBP said the consistently low level of credit availed by the private sector together with declining foreign investments were the main factors responsible for a stagnant economy.
Given this external-sector-centric approach of the regulator, some analysts believe that inflation would be no more a criteria for the State Bank to set the discount rate.
“Going forward, the forex reserves trend would dictate the (SBP’s) monetary policy more than inflation,” said Muhammad Sohail, a senior stocks analyst and CEO Topline Research.
The rate deciders at the bank themselves conceded in the monetary policy decision that they found it a main challenge to assign “appropriate weights” to these competing considerations.
SBP chides cash-strapped govt over violating fiscal discipline
