KARACHI: The State Bank of Pakistan (SBP) has attributed heavy government borrowing from the central bank and the consequential inflation spike to the deterioration of currency-to-deposit ratio in the banking system which had shown “contractionary” growth of 40 percent during the last three fiscal years from 2007 to 2010.
Furthermore, the central bank, stressing the need for a coordinated response to the changing macroeconomic climate, said a nominal growth of 24 percent in private sector credit from the banks during Jun-Nov 2007-10 had adversely impacted on the future productive capacity of the economy.
“A decline in deposits tends to have a contractionary effect on market liquidity and puts an upward pressure on market interest rates,” Governor State Bank of Pakistan Shahid H Kardar told businessmen at Federation of Pakistan Chambers of Commerce and Industry (FPCCI), here Monday.
The SBP governor stated that while currency in circulation had increased by 82 percent during June 2007-2010, deposits had witnessed an increase of only 40 percent.
In contrast, during June 2003-2007, currency in circulation had grown by 70 percent with total deposits in the banking system, excluding the government ones, rising by 104 percent. “These lasting trends are fueling inflation fear and keep interest rates high. Thus, if anything, the criticism on SBP’s current monetary policy stance could be that it has not been tight enough,” he reasoned.
Kardar was of the view that while currency in circulation had a strong positive relationship with overall inflation, deposits represented the major funding source for the banking system. Explaining the reason for SBP’s approach of pursuing a relatively ‘loose’ monetary policy, he said, it was the bank’s concern that a tight policy would further crowd out the private sector, thus reflecting negatively on the growth rate. “Faced with this trade-off, SBP has been trying to strike a very difficult balance between such considerations,” he asserted.
The governor was apparently disappointed by the nominal increase in private sector credits and indicated that private sector borrowings had grown only by 24 percent between Jun-Nov 2007-2010, compared to cumulative growth of 162 percent of June 2003-2007.
This, he said, in turn had been detrimental to the future productive capacity of the economy, making it more difficult to meet the relatively lower aggregate demand and bring inflation down. He, however, acknowledged that the government had considerably crowded out the private sector both through reduced availability and price of credit.
The SBP governor went on to record that any future strategy to control inflation must include coordinated and prompt responses to the changing macroeconomic conditions along with a concerted effort to raise the productive capacity of the economy.
He warned that any delay in implementing such a strategy would only make policy trade-offs more difficult to contemplate and result in continuing uncertainty pertaining to desirable economic outcomes.
Responding to various queries, he said the monetary policy had played its role in balancing macroeconomic disequilibrium, but other government policies had not been that supportive. “Had the SBP not responded, the inflation outlook and reserve position of the country would have been worse,” he added.
According to Kardar, the growth in broad money and thus inflation would have been much higher had the private sector also continued to borrow unchecked from the banking system along with the public sector.
He acknowledged that some observers might comment that cheap credit access to the private sector would have supplemented productive capacity and reduced the output gap, but given the scale of macroeconomic problems, it is highly unlikely that investments in the country, by both local and foreign investors, would have grown swiftly.
He explained that the central bank had determined that inflationary dynamics were based upon, in broad terms, inflationary mix of upward adjustments in administrated prices, persistent output gaps and inconsistent macroeconomic policies firing inflationary pressure. Kardar noted that in cumulative terms, the country’s economy had experienced an inflation of 66 percent between June 2007 and October 2010. “This is almost twice the level of inflation seen during June 2003 and June 2007, which was 36 percent,” he added.
The SBP chief said credit extended for ‘commodity operations’, including both wheat and sugar, grew by 288 percent during the last three years compared to 33 percent in the three years before that. “Borrowings of this scale would not have been possible without a rise in market interest rates,” he said, point out that government borrowing for financing its wheat, urea, and sugar trading operations was Rs 382 billion at just under three percentage points above the KIBOR.
This led to an influx of resources to the rural areas, which was used for higher expenditures on consumer durables and possibly other food items as well, he said and added that an initial ‘supply shock’ turned into a ‘demand shock’ and further reinforced anticipation of inflation.
Kardar elaborated on how heavily subsidised commodity prices including that of petroleum products, electricity and gas had resulted in heavy government borrowing from the central bank, another factor in present circumstances. Talking about the public sector enterprises borrowings, he said it partially explained the transfer of subsidies from budgetary expenditures directly to the power sector; this had grown by 305 percent during June 2007 and October 2010 compared to only 17 percent during 2003 and June 2007. “This contributed directly to growth in money supply and inflation,” he remarked. Both non-food non-energy (NFNE) and trimmed measures of core inflation validated this hypothesis, he added.
The SBP governor opined that reduction in subsidies unfortunately did not help in reducing the fiscal deficit and easing aggregate demand pressure. In cumulative terms, he said, the fiscal deficit grew by 146 percent in nominal terms during June 2007-2010 compared to 113 percent during June 2003-2007. “If we take out the interest payments, which have been mentioned as a factor adding to the fiscal problems, and look at the primary deficit, the fiscal driven aggregate demand pressures look more pronounced,” he said.
The governor concluded present stock of outstanding borrowings of the government from the SBP was in excess of Rs 1,500 billion as compared to only Rs 53 billion at end-June 2003.
