That the discount rate remains unchanged for the next two months is no breaking news; it was widely expected. The catch is in the wordings of the central bank governor. Unlike last time, when optimism, as regards the promises of his fiscal counterparts, was at the heart of the governor's speech, the policy statement this time spoke of 'caution'.
The reading between the lines is that 'let's not repeat 2008 in 2011 by choosing not to pass the impact of global shocks on to the domestic market'. While the monetary policy statement (MPS) acknowledged the disciplined government borrowing from the SBP and favourable external account and tamed inflation, it rightly placed more weight on the structural weaknesses within the system that exposes the fragility of macroeconomic improvement.
These structural weaknesses primarily include lower tax-to-GDP ratio, higher subsidies and energy sector circular debt. These are the root causes of higher deficit, the financing of which is not only inflationary but it crowds out the private sector while making debt management a daunting task.
"Although some measures have been announced to contain the fiscal deficit of FY11 and inflation has eased somewhat, more work is required to build on these initial efforts by maintaining progress on comprehensive tax reforms, transparent rationalisation of subsidies, and the development of a forward-looking debt management strategy", the MPS stated. In other words, all eyes are on FY12 budget.
The SBP cited the reasons for decline in inflation from 15.5 percent to 12.9 percent in two months as gradual dissipation of flood's effect on food prices, incomplete pass through of high international oil prices to domestic market and curtailment in fiscal borrowing from central bank and warned that future path of prices is contingent upon latter two factors. International oil prices outlook are feared to remain high on growing uncertainty in the global economic arena. The popular uprising in MENA region and natural calamity in Japan can result in high commodity prices, especially oil, SBP rightly noted.
"So far, the terms of trade shock has been favourable for Pakistan's economy. More than 90 percent of the incremental increase in export earnings during July - February, FY11 over the corresponding period of last year has been due to high international prices of Pakistan's exports. The contribution of high import prices, particularly of oil, to the import bill has been relatively low, but is substantial and rising", the MPS warned.
Knowing the uncertain negative shocks in the offing, the SBP was critical on the external budgetary flows. "Only Rs 48 billion were received for external sources to finance the budget during H1-FY11 against the budget estimate of Rs 230 billion for the year. If these external flows are not released in a timely manner, there is a risk of further substantial government borrowings from the banking system, which will make liquidity management more challenging", the MPS said.
SBP applauded the recent revenue enhancement and expenditure curtailment measures but is fully aware of short term nature of these steps. "Given the delayed announcement and temporary nature of some of these measures, the improvement in the fiscal position will require these efforts to be consolidated in the forthcoming budget", the MPS pointed out.
Sources reveal that everybody on the central bank's Monetary Policy Committee was on board with the decision of not making a change in the discount rate for next two months. However, the policy statement is quite vocal on 'not to get complacent, or else'. The persistence of reforms still remains missing and the absence of meaningful reforms is building the perception of economic agents about the credibility and direction of monetary and fiscal policies in controlling inflation and promoting sustainable economic growth.
Although, the build up in NFA and the reduction in government's borrowing from SBP have changed monetary aggregates a bit, the SBP warns that public borrowing relative to private is still very high. "Further, given the financing requirements of fiscal authorities, budgetary as well as non-budgetary borrowings for the procurement of commodities and addressing the circular debt-related issues, the likelihood of an ease in such borrowings is small", MPS added. In short, unlike last time, the tone is pessimistic as regards the government's role in taking tough decisions and rolling out the structural reforms. Indeed, the spirit is very much hawkish in the SBP camp.