M2 Growth: Feeding consumption

The money supply didn grow by much this year; but its growth remained highly skewed towards high powered money creation. Data for all but the last week of FY12 shows government borrowing from the State Bank of Pakistan is approaching Rs600 billion, close to the amount of money printed in 2008. Add to this bulging tally, about Rs300 billion that were pumped into the system through reverse market operations, and the resulting total of money creation surges to a whopping Rs900 billion. And then there is the government borrowing from scheduled banks, which has surged twice as high as last year. But the most worrisome fact about the bloated quantum of the federal borrowings is that most of the money was used to support consumption, not to enhance debt repayment capacity. And that is what has anchored inflationary expectations. Though commodity prices are mostly on a receding cycle, demand is being driven by steep money creation, as is evident from the surge in core inflation. Delving into the monetary report card; money supply increased by Rs782 billion (11.7 percent) this year versus Rs765 billion (13.24 percent) last year (first 51 weeks). The currency in circulation grew by a slightly slower pace compared to FY11, but not much to differentiate from what has been happening over the past few years. The stark difference is the change in the composition of monetary assets, which has skewed to domestic asset creation. This is not a good omen. NFA in the system fell by a massive Rs292 billion, compared to growth of Rs182 billion in the previous year. On the other hand, NDA soared by Rs1,074 billion, close to double to last years tally. Historically, the NDA to NFA ratio has proven to be positively correlated with inflation. NDA to NFA ratio is right now, higher than it was in 2008. On the (rather dim) bright side, credit to private sector is faring a little better. It surged by Rs184 billion this year; more than twice of last years tally. This shows that the economy is picking up; though in bits and pieces and with too many vulnerabilities. The foremost concern to the economy is the fall in the foreign reserves held by SBP. These reserves slashed by around four billion dollars in the past one year posing grave concerns for the near future. SBP liquid reserves are less than three months worth of imports and some lumpy payments could take us back to the 1.5-2 months of import cover which was the case back in 2008 when the country knocked on the IMFs window. Economic managers seem to have pinned hopes on the release of over one billion dollar in the form of Coalition Support Funds and other amounts pledged under the Kerry-Lugar Act. If and when these flows materialise, the looming balance of payments crisis may well be averted for a few more months. But as the heading of the financial account into negative territory last month foments; something more is needed to set the economy on a path of sustainable growth and prosperity.