Slashing the 9.5 percent discount rate by 50 basis points (bps) to be effective from June 24 for the next couple of months, the central bank Friday dubbed the implementation of a “reform-oriented and credible” medium-term fiscal outlook as essential for the newly-elected government to benefit from the post-May 11 evolving positive sentiments and lure investors.
Also, the central bank, in the monetary policy decision, said revenue collection measures like the one percent hike in general sales tax (GST), amending the tax structure for some goods and services and a phase-wise upward adjustment in power tariff might keep the Pakistan Muslim League-Nawaz (PML-N)-led government from arresting average inflation at the targeted 8 percent during FY14. In addition, the State Bank of Pakistan (SBP) also expressed concern over the flight of $143 million net capital and financial outflows from the country during the first 11 months of the outgoing FY13.
SBP also hinted that a declining inflation trend and below potential GDP growth made a case for further reduction in policy rate. For the 0.5 percent rate-cut, the SBP quoted declining inflation and low private sector credit as contributable factors.
A basis of its monetary policy decisions for the last four months, the central bank ignored the external sector this time while setting the discount rate, arguing that FY13 was likely to see the current account gap settling at a “manageable” 1 percent of the GDP. This, it said, signified very low risk from this source for external accounts.
The central bank also said if the new government wanted the ailing economy to reap the benefits of “evolving positive sentiments and lure domestic as well as foreign investors,” it would have to ensure effective implementation of a reform-oriented and credible medium-term fiscal outlook that the regulator said was “essential”.
“There has been a discernible positive change in sentiments post the election because of clarity on the political front,” read the Monetary Policy Statement (MPS) issued by SBP’s Central Board of Directors that met under the chairmanship of SBP Governor Yaseen Anwar.
The change in the behaviour of banks in auctions of government securities and reaction of stock market were two examples, the statement said.
Importantly, it said, there had been a considerable improvement in SBP conducted surveys of consumer confidence, expected economic conditions, and inflation expectations. The average CPI inflation for FY13 is likely at 7.5 percent against the targeted 9.5 percent.
“However, aggregate demand in the economy is expected to remain moderate, which could have a dampening effect on inflation,” it said.
Terming real economic activity as muted, the central bank in the MPS, said provisionally GDP would grow in FY13 at 3.6 percent. “Which is lower than the 4.3 percent target for the year,” it added.
With private fixed capital formation contracting by 1.8 percent for the fifth consecutive year, April’s 4.8 percent growth in Large Scale Manufacturing was too early to be termed as an emerging trend.
If a declining inflation trend and below potential GDP growth is any criteria, the state bank sees room for further reduction in the policy rate on two grounds. First, the SBP has been giving a relatively high priority to inflation in its monetary policy decisions over the last few years. Second, without further rate-cut, the real interest rate (policy rate minus expected inflation) would increase due to declining inflation. “High real interest rates are not helpful for supporting private investment in the economy,” the state bank said.
However, as indicated in the last monetary policy decision, the current balance of payments position and a structural imbalance in fiscal accounts suggest vigilance.
The SBP termed lack of foreign financial inflows, high fiscal borrowings from banking system, energy crises and uncertain security situation as formidable challenges for the country’s economic growth. “The real challenge continues to emanate from the lack of financial inflows,” it said.
“Add to this the ongoing payments of IMF loans and it becomes clear that the pressure on foreign exchange reserves has not abated,” it noted.
As of 14th June 2013, the SBP’s foreign exchange reserves stood at $6.2 billion.
“The stress in the balance of payments position was a prime consideration in maintaining the policy rate at 9.5 percent in the last two monetary policy decisions,” the SBP recalled.
Despite theses challenges, the central bank sees two developments.
Firstly, a noticeable change in sentiments, that could potentially favourably influence private financial inflows.
“Other than the overall economic outlook, investment decisions do take into account the relative political certainty that determines the continuation of economic policies for some time in the future.”
Second: Declining inflation has increased the relative real return on rupee denominated assets. “This could provide some room for downward adjustment in nominal returns to cater to broad macroeconomic considerations despite external account concerns”.
In this context, the bank said, a lot depended on the fiscal outlook.
The fiscal deficit for FY13 has been estimated to reach 8.8 percent of GDP, which is considerably higher than earlier projections.
For FY14, the federal government has announced a provisional estimate of 6.3 percent of GDP.
“From the monetary policy perspective, it is the financing pressure of the fiscal position that is the source of stress. Due to almost zero net external financing in FY13, the burden of financing the sizeable deficit of 8.8 percent has fallen disproportionately on domestic sources, in particular the banking system,” the central bank said.
During 1st July–7th June FY13, the fiscal borrowings from the banking system for budgetary support were Rs 1.230 trillion, including Rs 413 billion from the SBP. “The high level of these borrowings has kept an upward pressure on the system’s liquidity and thus short-term market interest rates and is restraining growth in the private sector credit,” the central bank said.
