SBP remains unmoved

As anticipated by this newspaper couple of days ago, the policy rate of the State Bank has been kept unchanged for the fourth time at 5.75 percent for the next two months. According to its Monetary Policy Statement (MPS) released on 28th January, 2017, this decision was made after assessment of the relevant developments and detailed deliberations in the meeting of Monetary Policy Committee (MPC). The outlook for inflation was benign. The average inflation was clocked in at 3.9 percent during the first half of the current fiscal due to smooth supplies of perishable items, stable exchange rate and government's absorption of higher international oil prices. The current trend suggests that average inflation during 2016-17 would be lower than the target of 6 percent. The current account deficit was, nonetheless, substantially higher at dollar 3.6 billion during July-December, 2016 compared to dollar 1.7 billion in the corresponding period of the previous year due to growing CPEC-related imports, decline in exports, absence of CSF and a slowdown in home remittances. This deficit was financed by an increase in bilateral and multilateral funding and a pickup in investment inflows.
SBP is quite optimistic about a higher GDP growth. The MPS states that "benefiting from the historic low interest rates, private businesses are actively borrowing from the banking sector for upgrading and expanding their businesses processes." This has been helped by retirement of government borrowings to scheduled banks and increase in bank deposits. Private sector borrowed Rs 375 billion in the first half of FY17 as compared to Rs 283 billion in the same period of last year and a substantial part of these borrowings was for fixed investment. This healthy credit expansion, higher production of Kharif crops, improvement in energy supplies and upbeat business sentiments "signal recuperating real economic activities". LSM grew by 3.2 percent during the first five months of the current fiscal and further expansion was expected on account of growing infrastructure spending and recent support of export-oriented sectors.
Although the business community and the government would have liked another cut in the policy rate for obvious reasons, sticking to the existing policy rate, in our view, was a better option in the given circumstances. The reasons for the support of such a stance are not difficult to understand. The level of inflation remains subdued so far but is higher than the past year and is likely to come under further pressure in the near future. The current trends in the foreign exchange market suggest that stability in the inter-bank rate of the rupee was not guaranteed and higher international oil prices have to be passed on to the domestic consumers sooner rather than later. If this burden was not shifted to the domestic market, the fiscal implications of such a distorted policy could be serious. Also, demand pressures in the economy could increase as private sector credit has tended to grow while government borrowings from the banking system, including from the SBP have not been adequately contained. The situation on the external front is simply alarming. The current account (C/A) deficit which is the main indicator of the external sector situation of a country has doubled to dollar 3.6 billion during the current fiscal. All the important components of the C/A balance are showing deteriorating trends. Home remittances and exports are down, CSF inflows would be no more available and no programme with the IMF is likely to be negotiated anytime soon. More worrying aspect is that the chances of improvement in the external sector are also very slim. Protectionist policies in the developed economies are gathering momentum while domestic productivity is still hampered by a host of factors like confrontation at the borders, political tensions within the country, corruption and poor infrastructure. The depreciation of the rupee which could encourage exports and contain imports is also not on the cards due to the insistence of the government to maintain the existing parity of the rupee. Overall balance of payments has not yet deteriorated and foreign exchange reserves have not been depleted due to foreign funding and pickup in investment inflows but these receipts are not likely to continue to give adequate comfort to the external sector.
A grim situation in the external sector and some rise in the rate of inflation might have persuaded the MPC of the SBP to increase the policy rate somewhat but such a change in stance seems to have been avoided for the time being due to its negative impact on economic activities in the real sectors. As the wording of the MPS shows, SBP is highly pleased with the expansion in private sector credit, particularly for fixed investment, retirement of government borrowings to the scheduled banks, rise in commercial banks' deposits, higher demand for consumer financing and growth in the LSM sector. Any increase in the policy rate might have wiped off some of the gains on these indicators. However, the MPC will be constrained to consider an increase in the policy rate if the present trend in the C/A balance continues and the inflationary pressures re-emerge. After all, it is the basic responsibility of a central bank to maintain price stability which is also a prerequisite to sustainable growth. Finally, it was somewhat disconcerting to see the Finance Minister hinting at the possibility of unchanged monetary policy stance in a meeting a few days prior to the announcement of MPS. This kind of attitude strengthens the present perception that SBP is not an autonomous institution in letter and spirit as provided under the laws of the land. Last but not least, Pakistan desperately needs an industrial policy. LSM growth is woefully dismal if one takes into account country's population growth rate. It needs to be around 7 percent to employ the teeming millions entering the employment age. The situation, therefore, brooks no complacency. Period.