Price pressure to persist as demand-supply gap widens

SBP in its monetary policy statement emphasised yet again on the implication of increased reliance on budgetary borrowing on domestic banking sources owing to lack of foreign funding and slippage in deficit. "The basic intermediation function of scheduled banks is being constrained as the fiscal deficit and the commodity operations of the government are financed by deposits at the cost of declining private sector investment", SBP aptly highlighted.
Similar words on banks' risk aversion towards the private sector owing to high NPLs were used by the SBP in its second quarterly report published last month. A policy action in coming months to force or induce banks to focus more on private sector, especially SME, cannot be ruled out in the coming months. As a 3.1 percent decline in real private investment expenditure and a 7 percent growth in real private sector consumption has resulted in output gap. "...output gap - the difference between aggregate domestic demand and the supply - is perhaps widening again, making it difficult to bring inflation down. Thus, along with rising debt the economy seems to have settled at a low-growth-high inflation equilibrium", MPS highlighted. This is a profound implication of rising debt and its servicing amid severe energy shortages. The low growth period of the last four years is driven by consumption demand and low investment expenditure is hurting the future growth potential.
SBP stressed that its solution rests with wide-ranged fiscal reforms. "For a sustainable fiscal path revenue-enhancing measures need to be complemented with renewed efforts to stem the leakages in the tax system, bring a wider range of incomes in the tax net, and effective expenditure control measures, especially the removal of untargeted and distortionary subsidies. These initiatives will be critical for reducing the stress on the fiscal position and to encourage entrepreneurship in the economy." MPS added.
The crux of the monetary policy is not on the pricing issue and varying policy measures that can be used by the SBP to strike a delicate balance between growth and inflation, rather over the time it has become more vocal on the need of putting the fiscal house in order to get the economy out of shambles.
SBP, like the other economists, is susceptible on achieving revised budget target of 5.5 percent of GDP and is expecting a slippage of 0.7 percent owing to the recent one off payment of Rs 120 billion to settle the old stock of power sector circular debt. One may wonder how many more adjustments will be made on the devil of energy debt before it comes to an end.
Nonetheless, the SBP acknowledged the improvement in current account situation which surprisingly showed a surplus in first ten months, subdued inflation expected to remain below the revised target of 14.5-15.5 percent and the government control on central bank borrowing.
But it rightly added "... caution needs to be exercised while assessing the outlook of the overall balance of payment position. The main reasons for this prudence include the sharp decline in international cotton prices in the last two months, likely continuation of oil prices at around $100 per barrel, and debt obligations that are due in FY12. Barring any unforeseen developments, these factors together with the continued suspension of IMF's Stand-By Arrangement (SBA), which has implications for other financial inflows, imply that the stellar performance of the external account may be difficult to sustain. Therefore, maintaining the current upward trajectory of SBP's foreign exchange reserves would be a challenging task." Thus a wait and see policy is adopted by SBP to keep interest rates at 14 percent.