The State Bank used to issue two Monetary Policy Statements in a given year. But in 2008, amid the volatile economic situation, the institution announced two additional interim measures and subsequently, in 2009, it decided to have bimonthly policy reviews to maintain a proactive approach in today's volatile macroeconomic conditions. It also set up a monetary policy committee.
This approach is not only preventing panic but also allows a smooth change in policy rate, if required. Unlike the sudden increases in the past - such as the 200 basis point hike in November 08, the recent hikes took place in a staged manner of 50 bps each in three consecutive policy reviews.
The reasons for recent hikes were a rise in inflation - as it averaged 14.4 percent in the July-November period against 11.7 percent in FY10, while the SBP increased the rate from 12.5 to 14 percent in a staged manner during August-November - and continued fiscal reliance on the central bank which deteriorated the NFA-to-NDA ratio, an indicator closely watched by the monetary policy department.
Empirically, the ratio has a close association with CPI. It marginally declined from 7.2 at the time of the last policy decision to 6.85 by January 8, on account of the inflows of $743 million from CSF, which was used by the government to retire its SBP borrowing.
This coupled with profits transferred from the SBP helped the government slash its central bank borrowing from its year to date peak of Rs329 billion to Rs154 billion by January 8. Moreover, the CPI inflation, which hovered around 15.3 -15.7 percent during September-December period, is likely to be in the vicinity of 14 percent in January-February owing to the high base effect.
The balance-of-payment, that was the prime reason for worst crises in 1998 and 2008 is in good shape, as for the first time in seven years, the current account has shown a marginal surplus in the first half of the fiscal year with stable rupee-dollar parity in past few months. Forex reserves are also at record high of $17.1 billion.
On the other hand, private sector battering is visible from the decline of the LSM index by 2.3 percent in July-November with the fall in November at a whopping 4.7 percent, yoy.
However, the above stated facts do not narrate that the economy is out of the abyss. The devil is in the persistent fiscal indiscipline and it is the chief reason for building inflationary expectations. Lack of political economic will to generate additional revenues may cause the government to revise FBR targets by Rs87 billion to Rs1,580 billion.
The subsidies are likely to soar on account of the populist decisions of not passing the hike in international prices to consumers and not rationalising the power tariffs to fill the gap between revenues and costs. The power sector circular debt continues to haunt macroeconomic stability amidst expectations of high crude prices, going forward.
Non-compliance of IMF conditions is hindering other donors and creditors to dole out the money. The government may have to print more money to finance its fiscal gap, while at the same time opt for massive cuts in development expenditure, which will hurt future growth.
Along with these demand pull factors, the global commodity index rise is likely to exert costs push pressure on inflation. So, it will be unfair to assume that inflationary pressures have subsided and the central bank may move to a softening stance. But given its high frequency of review with marginally improved indicators amid the 150 bps rise in policy rate in the last six months, real interest rates may remain slightly positive in the coming two months at a 14 percent discount rate. The SBP in its half year statement may adopt a wait and see policy by keeping the policy rate unchanged on Saturday.
MONEY AGGREGATES
With the start of the second half, note printing started picking up again. Foreign inflows of CSF and transfer of profits from SBP helped fiscal borrowing and the toll to the central bank reduced by Rs180 billion in a week's time. The very next week it increased by Rs61 billion to cross year to date Rs150 billion mark.
While the NFA and fiscal borrowing from scheduled banks remained virtually unchanged, credit to private sector fell by a hefty Rs40 billion to stand at Rs123 billion. This fall could be attributed to the end of working capital needs for cotton procurement as traditionally private credit in third quarter remains sluggish.
With an increase of Rs48 billion in currency in circulation and fall in private credit, the demand and time liabilities declined by a hefty Rs103 billion for the week ending January 8. The overall money supply fell by Rs55 billion or 0.95 percent to reach Rs496 billion.
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KEY MONETARY AGGREGATES AS ON JAN 8
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Rs (mn)
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8-Jan 1-Jan Change
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Currency in Circulation 267,579 219,490 48,089
Total Demand & Time Deposits 227,179 329,951 (102,772)
Broad Money (M2) 496,089 550,788 (54,699)
NFA 129,443 131,501 (2,058)
NDA 366,646 419,285 (52,639)
Net Government Borrowing 347,312 291,344 55,968
Borrowing for budgetary support 400,834 338,653 62,181
from SBP 153,878 92,400 61,478
from scheduled banks 246,956 246,253 703
Commodity operation (56,110) (49,913) (6,197)
Credit to non-govt sector 145,265 179,455 (34,190)
to private sector 122,827 162,953 (40,126)
to PSEs 21,622 15,686 5,936
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Source: SBP
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