SBP statement blunt, but not rude

June 11, 2012

RECORDER REPORT

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The Monetary Policy Decision (MPD) or Monetary Policy Statement (MPS) announced by the State Bank of Pakistan (SBP) on 8th June, 2012 contains no surprises. As widely anticipated, including the assessment of this newspaper after an analysis of various factors impacting the monetary stance, the policy rate has been kept unchanged at 12 percent for the next two months. However, what is highly significant in the Monetary Policy Decision (MPD) this time is much greater emphasis by the SBP on various challenges facing the economy rather than monetary policy imperatives of the country. Reading between the lines, one cannot escape the conclusion that SBP's pessimism about the economy is growing and it finds itself almost helpless to turn the tide and ensure monetary stability when fiscal policy of the country continues to be highly expansionary. Despite knowing fully well that the government is totally averse to reforms due to political considerations, SBP has stressed in no uncertain terms to drive home the fact to the fiscal managers that "the economy basically needs fundamental reforms to engineer a turnaround in economic performance". Showing its utter disappointment with the increasing price pressures in recent months, the MPD highlights the point that "inflation expectations cannot be effectively anchored to single digit targets without limiting fiscal borrowings from the banking system, particularly the SBP." Borrowings from the Central Bank had risen as much as Rs 1098 billion from 1st July to 25th May, FY12, with borrowings from SBP (on cash basis) expanding by Rs 414 billion during this period. Borrowings from SBP during a short period from 1st April to 4th June, 2012 had accelerated by Rs 310 billion, pushing the outstanding stock to Rs 1660 billion (on cash basis). Lamenting the government's behaviour to ignore legal requirements of borrowings from the central bank, the MPD has raised this pertinent issue by asserting that "this behaviour contravenes the SBP (Amendment) Act 2012, which requires not only zero quarterly borrowings but also envisages their retirement in the next seven years. Not surprisingly, the year-on-year CPI inflation has increased to 12.3 percent in May, 2012." Limiting and retiring budgetary borrowings from the banking system and implementation of consistent and credible fiscal policies would help in moving away from this undesirable situation. These statements seem to be like a desperate call by the SBP to the government and other stakeholders, particularly the parliamentarians, to constrain the authorities at the helm to stay within legal limits of bank borrowings. Not only would their failure amount to violation of law, it would strengthen inflationary pressures to an extent that would more than offset efforts, however noble, logical and sincere, aimed at providing any relief to the common man. SBP is also not happy with the performance of commercial banks. Censuring them for their complacency, the MPD states that "they are simply channeling the economy's incremental deposits, raised at 7 percent on the average, to government securities that give an average return of approximately 12 percent across different maturities." Banks perceive the government as a captive borrower and avoid the private sector without taking a hit on their profits. External sector developments used to be a plus point of economy but their behaviour during the current year has also been quite disappointing. The Current Account balance, which was in surplus in FY11, is estimated to be around dollar 4.0 billion in deficit or 1.7 percent of GDP during FY12. Accounting for repayments of the IMF loans, net liquid foreign exchange reserves had declined by dollar 3.5 billion to dollar 11.3 billion by May, 2012. The size of current account deficit as a percentage of GDP is again projected to be about 1.7 percent of GDP during FY13. However, due to anticipated rise in debt payments in FY13, the economy would need substantial external inflows to preserve the foreign exchange reserves. According to the SBP, the issue is not the size of the current account deficit but a profound lack of external inflows to finance it. Commenting on the recent depreciation of the local currency, the MPD says that "being a safe haven for investors, the US dollar has strengthened significantly against almost all currencies and Pak Rupee was no exception." We feel what the Central Bank has said in its Monetary Policy Decision, is certainly based on facts but the only difference this time is that it is unexpectedly quite blunt and straightforward. Here, one must not lose sight of the fact that there is a vast difference between being blunt and straightforward and being rude and sarcastic. In our opinion, MPD is not rude to fiscal planners and neither is it sarcastic. The SBP's argument, which is direct and to the point, may be due to the fact that it is increasingly being accused by the private sector of maintaining a tight monetary policy stance to ease inflationary pressures without getting the desired results. Its policies, therefore, are propagated to be flawed in the sense that neither the objective of price stability is being achieved nor is the monetary policy suited to spur growth and create more jobs. To dispel this impression, the State Bank seems to have decided this time to openly share its standpoint by saying that the real challenge to the economy and price stability does not stem from its policies but from the inability of the government to manage its own house and excessive reliance on the banking system to hide its own weaknesses. It has even spilled the beans that government is exceeding the legally binding borrowing limits from the State Bank by a huge margin to meet its financial requirements and the monetary authority of the country is almost helpless to check this violation. No wonder then, that price pressures, instead of abating due to high interest rates, are on the rise and there is no hope of any improvement if the government does not behave prudently. While the SBP has been making all the right noises in the recent past to force the issue of prudent fiscal management with a view to containing the price pressures and rehabilitating economy, the government, however, is least bothered. In his post-budget press conference, the Finance Minister revealed that budget deficit during the current year was going to be as high as 7.4 percent of GDP. Such a level of deficit is of course unsustainable and highly destabilising for the economy but the government, instead of tightening its belt and raising more resources, has again announced populist measures in the budget for FY13 to improve or brighten its electoral prospects. Most likely, it would again take the easy route of more bank borrowings next year to finance its reckless, wasteful and wildly extravagant spending. The advice of the Central Bank for sound fiscal management, active and dynamic banking to raise resources for higher investment and increased private capital inflows in order to stimulate the growth rate, improve the external sector accounts and reduce inflation would probably not be given due importance. Beating the opposition by a sizable margin of votes is much more satisfactory for the political leaders in an election year. Other problems can be taken care of later if the situation so permits. A somewhat encouraging development in this bleak scenario is the constant nudging by some saner elements to approach the IMF before the country is on the brink of default and inflation gets out of control to play havoc with macroeconomic indicators. The Finance Minister has revealed that he is in constant touch with the Fund due to the apprehension that the country could face problems in meeting its external obligations during FY13 because of widening of Current Account deficit and heavy repayments. After highlighting various issues in the foreign sector, SBP has also made the point that "the economy would need substantial external inflows to preserve foreign exchange reserves." Everybody knows the source of substantial external inflows. Such statements, therefore, point to the near certainty of going to the Fund for financial assistance sometime in 2012-13. Needless to say, that the country would be obliged to undertake an appropriate reform agenda in such an eventuality to stabilise the economy. On top of the agenda would, of course, be the reduction of fiscal deficit to a sustainable level and unshackling the monetary policy from carrying its heavy burden. An independent monetary policy in an enabling environment would then be able to deliver goods and place the economy on a sound footing along with monetary stability. The only regret is that our leaders in authority seem to be unable to make the right moves unless and until they are forced to change the course and proceed earnestly in the right direction. Inevitably, the economy will be running into more difficulties in the absence of some key remedial measures. The IMF can be one clearly intended step to rectify or improve the situation. The incumbent government would like to have general election by the middle of second quarter of fiscal year 2012-13 if it decides to go back to the Fund with a view to averting potential default by significantly improving Balance of Payment (BoP) position.