MONEY WEEK: The pitfalls of LSM fallout

The large-scale manufacturing sector's continued dismal performance exhibits the inherent weaknesses of economic recovery and overwhelms the scores gained on the external front. However, the spree in commodity prices is spilling over a positive impact on rural and semi-urban areas - paving the way for growth in the automotive sector.
The demonic energy circular debt is directly playing havoc with petroleum production and indirectly via power supply disruptions, hurting the rest of the large scale manufacturing sector, whereas the massive floods have left their mark on commodity-based value-added sectors.
A massive fall of 8.27 percent year-on-year, in July-December 2010 in petroleum production reflects under-utilisation of the refinery sector's capacity owing to its mounting receivables in the energy debt chain. It adds burden to the economy by way of additional imports. With sharp northward movement in international crude prices, the strain on imports will be significantly more in the coming months.
The positive performance in the current account, which is primarily attributed to over 20 percent growth in exports, has been undermined by 11.8 and 1.93 percent decline in manufacturing of cotton yarn and cloth respectively. Textile sector, the backbone of exports, is vulnerable to the volatility in international cotton prices.
Nonetheless, the silver lining is that recovery in cotton production next season is likely to partially offset any fall in cotton prices.
The brunt on economic slowdown, eroding purchasing power in urban centres, private credit crowding out and energy shortfall is written all over the performance of the other manufacturing sectors including construction, allied industries and many others.
Imported cost-push factors (mainly oil), persistent upward pressure on domestic demand by fiscal borrowing from the banking sector will not allow interest rates to taper off and keep on crowding out the private borrowers.
This, amid chronic energy mismanagement, might keep domestic supply shy of its full capacity with little or no expansion in the near future. Hence, the fate of recovery in many industries is in the doldrums.
Nonetheless, the losses in urban community (eroding purchasing power due to high agri commodity prices) are profits for rural people. This facilitates automotive sector and consumerism to grow in relatively untapped rural and semi urban segment.
However, rural growth is not enough to lift the overall industrial demand. Investor confidence is required to be boosted by better fiscal management, energy sector resolution and a consistent and rational policy framework. Lower fiscal deficit will help tame down inflation, private sector crowding in and more room for public sector development to boost future growth.
Nonetheless, the political arena is heating up whereas long-term remedies cannot be executed in weeks or months. The onus falls on the central bank, as short-term price stability and better current account balance amid poor LSM performance may give SBP a reason not to be hawkish in the coming monetary policy review.
Recent, T-Bills and PIBs cut-off yields and participation suggests that the market is also not anticipating a hike in interest rates in coming review.
But, in the absence of recovery in domestic supply, currency and prices will remain under pressure. Stagflation is likely to be the fate of economy for short to medium term.
MONEY AGGREGATES:
After a heavy central bank borrowing previous week, government was up to the task by slashing note printing by Rs51 billion for the week ending Feb 12. Fiscal borrowing from scheduled banks inched up by Rs19 billion while commodity financing continued its slow downward journey.
Credit to private sector increased by Rs14 billion while to PSEs virtually remained at the previous week's level.
Currency in circulation increased for yet another week to make the year to date increase at Rs273 billion which one and a half times more than the CIC in the corresponding period last year.
While demand and time liabilities declined by Rs39 billion to make the money supply to fall by 0.41 percent or Rs24 billion for the week ending Feb 12.

================================================================
KEY MONETARY AGGREGATES AS ON FEB 12
================================================================
                                         Rs (mn)
                                    12-Feb      4-Feb     Change
================================================================
Currency in Circulation            272,756    257,812     14,944
Total Demand & Time Deposits       195,478    234,365   (38,887)
Broad Money (M2)                   472,731    496,682   (23,951)
NFA                                127,171    125,325      1,846
NDA                                345,561    371,358   (25,797)
Net Government Borrowing           299,111    341,026   (41,915)
Borrowing for budgetary support    379,150    411,416   (32,266)
from SBP                           132,694    183,749   (51,055)
from scheduled banks               246,456    227,667     18,789
Commodity operation                (82,701)   (72,839)   (9,862)
Credit to non-govt sector          192,915    178,597     14,318
to private sector                  171,319    157,556     13,763
to PSEs                             20,795     20,234        561
----------------------------------------------------------------
Source: SBP
================================================================