Government greatly influencing monetary policy decisions

Finance Secretary dominated the thin SBP Board of Directors’ decision by overruling the status quo recommendation of central bank’s internal monetary policy committee. No wonder government pushed for a rate cut as this makes its debt cheaper at the cost of depositors’ savings. Isn’t it a conflict of interest?
The tone of monetary policy statement was mixed while acknowledging the deceleration in the inflation and improvement in current account position. The susceptibility remained on the overall external balance – SBP foreign exchange reserves reduced to $8.6 billion. The main culprit is the falling foreign investment as aptly stated by MPS that direct and portfolio inflows have come down from a peak of 7.2 percent of GDP in FY07 to 0.7 percent in FY12 and this trend is continuing in FY13.
The task in hand is to keep a delicate balance between spurring credit demand including imports and attracting foreign currency assets, while inflation is tamed. The private credit remained muted despite 400 bps cut in policy rate in the past 18 months. This implies relative inelastic behaviour of private credit demand to the interest rates given the energy constraints and lawlessness.
The equation becomes simple to entice foreign flows by keeping the return of rupee dominated assets higher. This recipe of further rate cut is not desirable especially when the currency is fast approaching the psychological barrier of Rs100 per USD. But the final call was other way round. Sources privy to central bank revealed that presentation of Deputy Governor to the board was to keep rates unchanged.
The problem of rupee depreciation has fiscal implication by inflating foreign debt in the rupee term cited SBP. And the elephant in the room is none other than persistently high fiscal deficit and growing debt well beyond the system’s capacity to repay it.
In the absence of meaningful fiscal reforms and elusive foreign funding of deficit, the onus of financing solely falls on domestic sources, predominately on banking. “During 1 July – 30 November, FY13, the fiscal authority has borrowed Rs586 billion from the scheduled banks and has retired Rs106 billion to the SBP. Consequently, the level of outstanding liquidity injections by the SBP, at Rs615 billion as on 14 December 2012, remains high,” SBP stated.
This liquidity injection has become a permanent feature and its routing to government borrowing is creating inflationary expectation. Plus, rupee depreciation is inflating the imported goods, having a cascading effect on prices of domestic goods and services. Hence, the chances of inflation to bounce back are high and that is the reason SBP expects full year inflation at 9.5 percent which means CPI is estimated to be over 10 percent in the remaining seven months.
It seems like the interest rates have now bottomed out, and going forward the hawks at SBP may not allow the government’s nominee to dominate. This also calls for a full strength board at SBP as the three member board with only one independent member with no representation from private sector and economists’ community is paving ways for tilted decisions. Nothing like reviving the Monetary Policy Committee comprising of an SBP team, board members and two independent eminent economists!