MONEY WEEK: private crowding out

The private sector is going to be cornered after being credited Rs211 billion in the second quarter. The signs are visible. Credit to the corporate sector historically slows down in the second half of the fiscal year - in FY10 Rs109 billion was advanced to private borrowers in the first half while the sector retired Rs139 billion in the second half and the same story goes for previous years.
This year is more comparable to FY08, some call it déjà-vu of FY08 - political motives are maligning the economy. While there are some parallels to draw concurrently, there are also lessons to be learnt. Continuation of subsidies on popular demands is swelling the fiscal deficit, while its financing could be a touch different, at least as promised by the government and endorsed by the SBP governor.
Unlike FY08, where magnetisation of deficit touched Rs689 billion, there appear to be some efforts to contain note printing in FY11. After peaking in December, the SBP borrowing toll reduced to Rs115 billion by end-January.
The more than Rs200 billion slash is by virtue of receipts of the Coalition Support Fund money, transfer of quarterly SBP profits, and more inclination towards scheduled bank borrowing. Fiscal financing from commercial banks increased by Rs157 billion to reach Rs245 billion from mid-December to January end.
Ever increasing reliance of deficit financing on commercial banks is critical for private borrowers as both have to compete on the same pool of scarce resources. The government being the less risky option is always a preference for cautious bankers in times of high private toxic assets.
Nonetheless, seasonal demand by private borrowers is going to taper off in the second half. Out of the Rs211 billion credited in the second quarter, over 90 percent are for working capital needs which historically are retired in the third and fourth quarters amidst lesser needs of working capital in the second half of the fiscal year.
There are two sides of the picture and none is bright. On one hand, long-term investment needs of the private sector is going down on lack of continuity of government economic and industrial policies and the poor law and order situation despite promising demographics and immense potential in economic growth in various sectors. On the other hand, whatever liquidity is in the system is going to the preferred customer - the government treasury.
With the government''s promise to freeze SBP borrowing at September 2010 levels, there is going to be more pressure on commercial banks'' borrowing and this might inch interest rates up on higher supply-demand gap despite keeping the policy rate unchanged in the last review. However, working capital retirement might provide an adequate supply to keep interest rates in check.
As during January-February, some buffer reserves of IMF''s unutilised bridge financing and low private sector needs will not create any chokes in liquidity. It is visible from the overwhelming response by participants in the latest T-Bills auction which resulted in a slight decline in the cut-off yields as well.
But any fresh demand from the private sector will surely put upward pressure on rates and make it difficult for the SBP to manage liquidity and maintain the corridor.
MONEY AGGREGATES:
Currency in circulation declined by Rs24 billion in the week ending January 29 to make the year-to-date increase at Rs227 billion. This is much higher than Rs147 billion taken out of the system in the corresponding period last year.
Two chief reasons cited for the sharp increase in CIC are the boom in rural economy which is largely a cash economy and magnetisation of the fiscal deficit. So with limits on SBP borrowing, if implemented, some fall in CIC may be witnessed in the coming months.
NFA virtually remained at the previous week and a similar tale to tell on NDA. Within the NDA, government borrowing increased by Rs12 billion, primarily from scheduled banks of Rs24 billion which was partially offset by offloading of SBP toll.
Private credit increased by Rs7 billion, however, credit to PSEs declined by similar number. Overall money supply virtually remained at previous week''s level.

================================================================

KEY MONETARY AGGREGATES AS ON JAN 29

================================================================

                                       Rs (mn)

                                    29-Jan     22-Jan     Change

================================================================

Currency in Circulation            226,699    250,513   (23,814)

Total Demand & Time Deposits       214,639    189,844     24,795

Broad Money (M2)                   445,846    444,871        975

NFA                                137,572    139,023    (1,451)

NDA                                308,273    305,848      2,425

Net Government Borrowing           299,353    287,819     11,534

Borrowing for budgetary support    359,499    344,581     14,918

from SBP                           114,506    123,637    (9,131)

from scheduled banks               244,993    220,944     24,049

Commodity operation                (62,672)   (59,338)   (3,334)

Credit to non-govt sector          173,269    172,151      1,118

to private sector                  154,208    146,784      7,424

to PSEs                             18,254     24,558    (6,304)

----------------------------------------------------------------

Source: SBP

================================================================