In an exclusive interview with the Business Recorder the other day, the State Bank Governor Shamshad Akhtar touched upon a number of issues of monetary policy in the country. However, the most important topic discussed was the restructuring of export refinance scheme on the lines that would retain its potential for export promotion but restrict its impact on inflationary tendencies in the economy.
According to her, the State Bank has decided to extricate itself from export refinance scheme but this would not mean higher borrowing rates for exports. Instead, banks will continue to provide loans on low rates for refinancing of exports from their own funds and the difference in interest rates will be paid by the government. The State Bank will decide what difference will be paid to the banks.
At present, export credit is provided at 7.5 percent per annum and the margin enjoyed by the banks is 3 percent. The change in policy would not affect the industrial sector at all because industries will continue to get export credit on the same terms and conditions.
Further, explaining the rationale of change in modus operandi of export finance, the Governor revealed that export refinancing scheme has contributed excessively to reserve money growth this year which has added to money supply and inflation in the economy and the State Bank wants to take out every inflationary element from its monetary policy.
Moreover, export refinancing, in any case, was unnecessary and burdensome. Even India has abolished export refinance and only interest rate differential is provided in their scheme.
This change in policy strategy by the State Bank in respect of export refinancing reflects largely its growing unease over the current rate of monetary expansion and high inflationary pressures in the economy. As its latest quarterly report issued on 26th May noted, money supply had accelerated by 12.1 percent duty July-April FY07, exceeding the 10.8 percent growth recorded during the corresponding period last year, and the target of 13.5 percent for the fiscal year 2006-07 was likely to be exceeded.
CPI inflation had been stubbornly high at 7.9 percent during July-April, 2007 and was projected to remain in the 7.5-7.9 percent range during the current year. In this kind of environment, the surge in money supply expansion was "a more challenging development, given that this has the potential to cause a resurgence in demand pressures in the economy."
These observations by the State Bank Governor were a clear indication that some money supply restraining measures were in the offing, and we feel that the decision to reform the export refinance scheme on the proposed lines would help contain reserve money growth, which would reduce the credit creating potential of the banking system.
A lower flow of credit would decelerate money supply growth and curb effective demand in the economy which, in turn, would help in softening the price pressures in the country. It is easy to understand why the present mechanism of export refinance system through counter-finance facility provided by the State Bank, was adding to the reserve money while the new scheme would be financed entirely through the banks' own resources and, therefore, would not contribute to reserve money growth.
As a side-effect the saving rate in the economy could also improve somewhat because in order to earn a margin on export finance, commercial banks would now have to make more deposit mobilisation efforts. Whether the margin would be paid by the government or the State Bank is, however, a largely irrelevant issue, since profits of the State Bank are transferred to the government and at the end of the day the amount of subsidy involved would not make any difference to the budget of the government.
Other observations of the Governor in the interview also make good sense. She revealed that State Bank has impressed upon the government to minimise its reliance on central bank borrowings and through effective communication, the government has now understood the State Bank's point of view. The government should resort more to non-bank borrowing sources including sales of PIBs, the modalities of which would be discussed soon. Also, the State Bank would like to discuss with the Ministry of Finance its financing requirements on a quarterly basis.
We hope that these anti-inflationary measures suggested by the State Bank would have the desired effect. In this connection, it may be added that State Bank of Pakistan Act is very clear on government borrowing from the central bank.
Under Section 9A of the Act, the Central Board of the State Bank could "determine and enforce, in addition to the overall expansion of liquidity, the limit of credit to be extended by the Bank to the Federal Government, Provincial Governments and other agencies of the Federal and Provincial Governments for all purposes, it being understood that the Governments will meet their additional credit requirement directly from commercial banks through market based auctioning system to be conducted by the Bank."
For 2007-08, bank borrowings including those from the State Bank have been estimated at Rs 81 billion (net of operational shortfall). It would be better not only to stick faithfully to this projected figure but rely less on financing from the State Bank.
Talking about the position of provincial finances, the Governor revealed that the overdraft position of provinces is now manageable. Both Sindh and Balochistan had done pretty well in this respect. However, Governor was not happy with the overdraft position of railways which she termed as alarming. While the improvement in financial position of provinces is a welcome development, the overdraft position of railways is an indicator that claims made by high authorities of this organisation in this regard are probably not true.
Overall, we feel that thrust of the State Bank's policies as enunciated by the State Bank Governor is in the right direction. However, only time will tell how far these are effective and adequate in combating the inflationary impulses in the economy which is the main objective of a central bank.