No matter how it is happening, but it is a fact that on paper economic performance has shown improvement. When the economy is meeting numbers in tough conditions, it is difficult to criticise the economic mismatches or weak fiscal policies. Despite energy shortages and a lackluster export growth, overall growth momentum, according to economic data, is in good shape. Inflation is on a constant decline reaching a 12-year low.
Both Fiscal and Trade deficits have surely narrowed down, though the targeted fiscal numbers could be difficult to attain. A robust trend in remittances, which is the major economic contributor, continues to make strides and has surged to an all time high, helping Foreign Exchange Reserves to climb to new highs, which is good enough to meet 3-month imports. A combination of factors such as a sharp slide in oil prices and external monetary support has complemented the ongoing economic upsurge, compelling rating agencies to upgrade Pakistan's credit ratings to positive from stable.
This could be a glimmer of hope for economic revival, but it is not sufficient enough to ensure future economic stability, unless extraordinary efforts are made to correct. Saturday's monetary policy announcement and the remaining 3 more MPSs (monetary policy statements) in the current calendar year have a huge role to play that should align with the inflation figure.
Similarly, it is the Ministry of Finance's responsibility to play an important role to support the SBP policy stance by slashing Pakistan Investment Bond's coupon rate accordingly and simultaneously protect pensioners and old age NSS holders by offering them special rates. There is no change in my view from my last post in Business Recorder (March 08), as I still see inflation dropping slightly below 4.75 percent by the end of current fiscal year and to close around 4.50 percent by the end of December 2015.
A short spike in prices can be seen in Ramazan if the government is unable to manage food prices, which would be a temporary affair and may not have enough legs to move inflation sharply higher. Nor should we expect a further oil price hike in the international market, as oil has either seen the top or is close to it unless Iran's nuclear dispute resurfaces.
It is most likely that on June 30th some sort of understanding will be reached, which means sanctions on Iran will be eased that will provide room to flood the market by nearly one-million barrels of oil per day, which will lead to further softening of oil prices. From Pakistan's perspective, Chinese investments have two dimensions. One is strategic, which does not require discussion to protect our national interest. But the second part, which is a commercially related transaction that is huge in size, needs more clarity and understanding. This is why both SBP and MOF should sense the urgency and are required to take proactive measures, so that the opportunity is not lost.
They are required to jointly act by sharply easing discount rate and sharply reducing PIB coupon rate. Though this is just the beginning, as it is a memorandum of understanding (MoU), if the government wants to execute the deal, it is important to understand the cost factor. The reality is that it is purely a commercial deal and not a gift/grant and unless the Chinese government has agreed to provide money on special condition, which does not look a possibility, because on all commercial lending, only commercial rates applies. Nearly 72 percent of the proposed MoUs are energy related transactions that stretch over the next 15 years.
Overseas commercial financing of any transaction has many risks involved that could be in the shape of a cross-border risk, credit risk, exchange risk, liquidity risk, price risk, interest rate risk and currency swap risk. Hence, there is no point to artificially maintain a high discount rate policy against low inflation. The inflation trend is clearly in a descending mode, though we see some exceptions in the month of Ramazan, which should be temporary.
Therefore, it is extremely important to understand the market condition and the risk involved and what businesses are demanding because at current KIBOR rate or minor downward adjustment of Discount Rate plus cost of various risks applied on all commercial transactions, the Chinese transaction will not be feasible. Similarly MoF should realise the sensitivity of the Chinese transaction that is spread over fifteen years, which is a long period of time. Because earlier, MoF instead of acting proactively, had already acted belatedly by offering to market PIBs at a very high yield and coupon rate that saw a sharp rise in the country's domestic debt.
A constant fall in inflation rate is indicative that it is a clear case of behind the curve that I had mentioned frequently in my previous write-ups. So if yield and coupon rate of government paper do not align with the discount rate, the higher lending cost for longer dated maturities will discourage investors. In all probability, it is imperative for our Central Bank to use meaningful monetary policy tools for achieving both growth and inflation objectives. In past few years, SBP was only targeting inflation; and it failed to spur growth.
Presently, the challenge is faced by both SBP and MoF and they are required to act in national interest or else both will be solely responsible if the opportunity is lost. A sensible strategy for the SBP is that it is required to reduce discount rate gradually and coupon rate accordingly until December 2015 by another 250-300 basis points in line with inflation and global interest rate trend.
As per need, SBP and MoF are required to make joint efforts to use the monetary and fiscal tools. Pakistan's Central Bank should apply its maximum monetary tools by gradually reducing its discount rate. Banks should be discouraged to use discounting window that can be done by keeping the interbank market liquid and to make its target rate effective. SBP should widen the corridor rate that will give an ample space to banks' lending. In line with the policy rate and to encourage business activity, SBP should reduce refinancing rate accordingly. And lastly, SBP should learn a lesson from investment banks and should ensure that this money does not flow into Bonds or Stock Market.
(The writer is former Country Treasurer of Chase Manhattan Bank)
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