There is a strong correlation between the net domestic assets to net foreign assets ratio (NDA/NFA) and inflation. Currently, the former is headed in the wrong direction and that is anchoring inflationary expectations. NDA/NFA worsened from 7.6 times to 10.4 times, in the first seven months of this fiscal year. The monetary policy department's recommendations to the board must be emphasising this fact at tomorrow's policy review.
On the face of it, broad money growth is restricted to 4.3 percent this fiscal year to date compared to 7.7 percent in the corresponding period last year. Couple this with inflation that has dropped under 11 percent and the chattering of doves, calling for monetary easing becomes audible. The argument for lower rates is always compelling, considering the dire need for economic growth of at least 7 percent per year, just to absorb the influx of two million youth entering the work force, each year.
But the devil is in the detail. NDA grew by 1.5 times more than the corresponding period last year to stand at Rs 450 billion as of January 27th, 2012. NFA figures are not much to boast over, considering the decline of Rs 165 billion. Deteriorating current account and ever falling financial accounts are points of concern; sour relations with the US are keeping Coalition Support Fund flows and any other form of aid or loan from the bilateral and multilateral agencies, away from these shores.
The onus of fiscal gap financing is entirely on domestic sources; primarily on the banking system as money raised in the first half through NSS has been less than Rs 100 billion. It is pertinent to note that quasi fiscal borrowing is slashed by close to Rs 350 billion. Part of this is due to lower commodity prices, but the lion's share of this debt just got bumped up to sovereign status.
There appears to be a marked difference in the definition of public debt, between the ministry of finance and the State Bank of Pakistan. In fact the difference is about the size of funds used to finance quasi fiscal operations. But this grey area is virtually no more. The conversion of circular debt and commodity financing into T-Bills and PIBs has further stressed the alarmingly high public debt.
The good omen is that it created space for the private sector to borrow more from the banking system; especially in the power sector. The numbers are demonstrating this; private credit increased by Rs 221 billion in 7MFY12 versus Rs 155 billion in the corresponding period last year. But this is still too little to boost growth.
The elephant in the room is government borrowing from the banking channels - it is at the staggering level of Rs 794 billion, this year to date as compared to Rs 358 billion in the corresponding period last year. Government borrowing from SBP is comparable to last year's numbers. The worrisome fact is the sharp increase in fiscal reliance on commercial banks which is at a whopping Rs 652 billion. And this ordeal hangs a question mark over the ratings of banks. The central bank should be thinking about putting upper limits on commercial bank's lending to government; or use the fund's route to exercise it.
The IMF has already expressed its resentment towards monetary easing; what it considers to be too accommodative, as well as fiscal funding reliance on commercial banks. But this cookie will crumble at the State Bank tomorrow. Should there be an upper limit on government borrowing from commercial banks? Can a balance be struck between countering inflation and spurring growth? The first can be contained through demand management. The second warrants affordable and uninterrupted supply of power; which is largely outside the central bank's realm.
Remember, Governor SBP has spelt out the intentions of the central bank: to keep real rates close to zero. With full year inflation expected to be around 12 percent (7M average: 10.8 percent) owing to upward revision in energy prices and rising crude prices in the international market; the cautious approach is to keep the rate unchanged at 12 percent.