John Maynard Keynes taught us how, through lower interest rates and increased government spending, countries can ensure that the economy operates near or at full employment. Unfortunately, however, none of our policymakers in the realms of politics and finance, seems to hold this view any longer.
The outlook for 2011 remains problematic. A very difficult and bumpy ride lies ahead as Pakistan's debt requires a parliamentary waiver in order to earn legitimacy as it has already breached 60 percent of Fiscal Responsibility and Debt Limitation Act (FRDL). Some of the major challenges are: low growth, high inflation, rising unemployment, continued fiscal indiscipline, growing poverty, surging food and energy prices, more expensive credit to private sector becoming more and more expensive, alarming increase in government borrowing, profound circular debt, poor revenue collection coupled with increased spending, growing subsidy and low foreign investments. One of the most important factors is also the failing commitment to IMF. A sustained flow of home remittances from overseas Pakistanis happens to be the lone consolation.
Rupee/dollar parity: We seek to project a 1.25 percent fall in the value of rupee against US dollar by the end of current fiscal year (June 30, 2011). Rupee could lose another two percent of its value in the remaining two quarters of the calendar year 2011. On December 31st, 2010, the rupee closed at 85.64 compared to last year's end of 84.24 - a decrease of 140 paisa or 1.7 percent of its value against the US dollar for the year.
-- Domestic market view
-- Growth and hindering factors
Pakistan's economy witnessed another difficult year. In 2011, our economic mangers may face even more difficulties due to more supply side shortages causing more increase in food prices in the domestic market and surging oil prices in the international market. Food imports and POL imports are likely to put pressure on the balance of payment (BoP) despite record remittances. Depleting foreign inflows and slow export growth may lower the forex reserves.
In the current fiscal year, remittances are projected to close above $10.5 billion. However, a small jump may be seen in the import figure due to higher oil and food prices, which are projected to surpass $35 billion mark.
The current account deficit is projected at five percent. There is already immense pressure on fiscal deficit, which has already worsened as much as seven percent and is inching upward every month.
The ideal combination in a booming economy is high growth, stable prices and low interest rate. Our central bank has an extremely difficult task to perform; it is forced to maintain tight monetary policy hampering growth due to persistent fiscal slippages. As a result, it has to maintain a mix of somewhat contradictory policies. While raising its policy rate every quarter it allows commercial banks to maintain high advances-to-deposit ratio to ensure credit to private sector putting banks in an awkward position since borrowers have already utilised all the available credit facility. Non-performing loans (NPLs) of over 10 percent further confirm that the SBP should have pulled its purse strings much earlier by raising the Cash Reserve Ratio (CRR). At present, banks cannot provide nor do they have enough room to take further risk on majority of their old borrowers. Economic conditions obtaining in the country for two to three years hardly provide any opportunity for new business ventures. Banks' book may be showing average annual rise in deposit, but on an average eight percent of liquidity shown in deposit is generated through interest accrual, which is due to higher return in investment in less risky government securities.
Interestingly, total investment in government securities has reached 40 percent, cash reserve money placed with SBP is five percent, NPLs are 10 percent, but scheduled banks' advances are over 70 percent: a whopping total to 125 percent. Although a small percentage of investments is held by corporate and financial institutions, it leads to severe credit crunch.
SBP as a banker to the government tries to shift government borrowing from SBP to commercial banks through its OMO operations with an eye on fortnightly government paper auctions.
With no positive sign of reversing the rising fiscal deficit, SBP is persisting with its tighter monetary policy stance to tame rising inflation while allowing growth to come down. We believe this present trend would continue and it would certainly hurt growth prospects. Therefore, the growth graph continue to show a declining trend, tilting towards 2.5 percent to 2.7 percent by the end of current fiscal year, with a strong possibility of a further decline in the last two quarters of 2011, unless sufficient money is provided to private sector to stage a comeback.
Persistent rise in unemployment and high poverty rate call for a soft interest-rate policy stance for higher growth. Tight monetary policy alone did not contribute to inflation coming down from 25 to 11 percent. The success was achieved as it was ended by the fiscal deficit coming down from nine to 5.5 percent. With fiscal deficit going up again to over 7.5 percent, inflation has already reached 14 percent.
-- Inflation and discount rate
We expect inflation to touch 16 percent by June 30, 2011 as a result the SBP money growth target of 12 percent may be breached. Therefore, we are anticipating 100 to 150 basis points (bps) rate hike in the calendar year 2011. Rate hike is likely to move in line with inflation. Reduced government borrowing and better crop production may give some respite in the later half of current calendar year in case budget makers can get their act together in FY 2012.
-- Exchange rate - Rs/USD
The secret of rupee's current stability is largely based on IMF's stabilisation support, higher inflow of remittances and SBP's willingness to hold rupee at current levels. Although, this writer is no fan of a weaker rupee, he cannot overlook the fact that stronger regional currencies provide sufficient opportunity to exporters to become highly competitive. However, higher inflation compared to our trading partners would be responsible for the weakening of rupee.
One can expect rupee to hover between one percent to two percent band in the remaining two quarters of current fiscal year to close around Rs 86.70 by December 31, 2011. However, in the last two quarters of 2011, rupee could come under increasing pressure due to deteriorating economic indicators and lose another two percent of its value. Foreign exchange reserves could come under pressure due to listless FDIs, higher import of oil and food. Hopefully remittances would continue its upward journey to touch yet another new all time high and is likely to get closer to USD 11 billion. If we compare with the BIS global remittances figure of USD 400 billion, in terms of percentage our remittances share is a mere 2.6 percent.
-- Currency in circulation
It has reached an alarmingly high level of Rs 1.577 trillion or 32 percent; it appears to be beyond anyone's control. The fast pace of growth in currency in circulation is caused by weakening of rupee, surge in food prices as a result of sharp hike in governmental support price. Giving a mere five percent in savings account while earning 13.5 percent through investment in T-bills has cumulatively resulted in a phenomenal increase in currency in circulation and is also responsible for a fall in national savings rate that has gone down below 9 percent.
An upward revision of National Savings Scheme rate is the correct move and depositors should shift their funds from banks, offering low return to NSS portfolio. An upward revision of NSS rates should also help in attracting cash money.
-- Circular debt and subsidy
Circular debt and across-the-board subsidy are two big monsters that require constant check. I do not see quick adjustment of circular debt because of low revenue collection. Moreover, we have a bullish view for oil and I am expecting oil to breach USD 100 a barrel in the international market, which also means that if my call is correct then more pressure will be seen on circular debt if prices are not adjusted quickly. A quick price adjustment is the only answer to the problem, which is politically a tough decision to make.
Similarly, subsidy in certain areas such as energy is unavoidable due to current price structuring. Time lag is main cause, because petroleum prices are quoted on a daily basis in the international market, but in our country prices are fixed on a monthly basis. Oil companies fixing their prices on daily basis based on international market price would have been a better option, which would be fair to all and competitive too. PSO should take the lead of benchmarking of oil price, which will force oil companies to sell oil at competitive price at their outlets. Monthly oil subsidy ranges up to around Rs 12 billion, which is annually roughly Rs 230 to Rs 240 billion. Another Rs 50 billion annual subsidy is required for wheat and sugar for warehouse cost and wastage, which can be minimised with better management.
-- International Monetary Fund
It was a wise move to ask for an extension period from the International Monetary Fund to settle trade transactions and obtain bilateral loans. Any such move would have forced the rating agencies to act quickly in chopping country's rating. Doing away with the IMF would also have compelled other multilateral lending agencies such as the World Bank and Asian Development Bank to halt all their future lending to Pakistan.
The extension period has only a breather. Overall financial account position of the country remains very weak. The country is yet to receive USD 3.4 billion in two tranches of USD 1.7 billion each from the IMF. This money will only be released after the IMF review and we do not expect these funds to be released in this quarter. Pakistan will receive half the amount before June 30 and the remaining half part is expected to be released after another review in the first quarter of next fiscal year.
On books, Pakistan has a forex reserves position of USD 17.2 Billion, out of which commercial bank deposit is USD 3.7 billion. SBP has Fx reserves of USD 13.4 billion, out of which it owns a little less than USD 6 Billion and the remaining part is IMF money. There is no other major source of inflow in the calendar year 2011. Hence, surging global oil and food prices could pose a big threat to BoP, which could start eating away IMF money if oil and commodity prices do not ease.
-- Debt position
It is at a very precarious situation as Pakistan's external debt has reached USD 58.4 billion and domestic debt has spiked to Rs 5.348 trillion or USD 62.44 billion. Based on GDP size i.e. USD 185 billion, Pakistan's official debt-to-GDP ratio has reached 65.32 percent, breaching Fiscal Responsibility and Debt Limitation act (FRDL), which needs to be presented to the parliament in January to obtain a waiver.
What is extremely worrying is that as per SBP web-site "Unfunded Debt" shows a figure of Rs 1.512 trillion. If this amount is taken into account and added to the domestic debt figure of Rs 5.348 trillion, then the debt position has actually reached 74.86 percent. This entry needs clarification. The debt figures are available at https://www.sbp.org.pk/ecodataldoinesticdebtout.pdf.
-- PIB - Treasury bills and sukuk
Banks and financial institutions are enjoying hefty returns offered on investments in government securities that have broken all previous records. Investment in T-bills has reached Rs 1.450 trillion, PIB holding is Rs 516.5 billion and Sukuk has jumped to Rs 131.3 billion. Total investment in government securities has reached 40 percent while cash reserve money placed with SBP is five percent, NPLs blocked money is 10 percent, which means tighter credit for private sector.
Caution is required when buying government securities, as excessive purchase of government security is turning out to be a new problem. It is noted that against quarterly maturities, MOF comes up with fresh target of 10 percent increase, which means the target is rolled over with (P + Return) and new higher target is offered.
Bank's rating is based on many factors. But recent downgrading of major Pakistani banks by global rating agencies is due to excessive investment by banks in government securities. Despite downgrading of banks the rating of banks is still 2-notch up if compared with Pakistan's rating. Rating agencies will be keenly watching the bank's investments in government securities. The reason is that when banks buy government securities their exposure is on government of Pakistan, which is already struggling on many economic fronts such as circular debt and loss-making state-owned entities.
The risk is that if revenue collection falls, targets will be increased and there is a limit to everything. T/bills yield will be 15 percent and 10-year PIB yield should surpass 16 percent by June 30, 2011.
Continued