TREASUARY FUND MANAGEMENMT
PREDICATION OF UPCOMING MONETARY POLICY
PREDICATION
ABOUT NEX`T MONETARY POLICY STATEMENT
OVERVIEW
Pakistan’s
economy is currently passing through the most difficult phase of its economic
history. A robust economy has been transformed into a fragile one due to four
years of total neglect by the political leadership and dubious policymaking and
implementation by a weak and frivolous economic team.
It is
an undeniable fact that Pakistan’s economy is currently in bad shape.
Investment has fallen to a 40-year low and economic growth has slowed to an
average of less than three percent per annum over the last four years. Slower
economic growth means fewer Pakistanis getting jobs and fewer Pakistanis
climbing out of poverty. These are the outcomes of the types of fiscal and
monetary policies pursued by the government over the last four years.
Predication of upcoming Monetary Policy
With
reference to the second quarterly report , the Government announcement zero
quarterly limits its borrowing from SBP, and the projections of the relatively
low current account deficit and more favorably the inflation rate remain close
to the 12% in t6he beginning of the fiscal year ,FY12. It reflects the central bank to follow the
accommodative policy rate .The central Bank was condensed the policy rate
by 200 Bps (Basic Points)(2%)
Following is the text of SBP Governor’s press statement on Monetary
Policy:‐
‘The basic challenge faced by Pakistan’s economy is financing its fiscal and
external current account deficits. The size of these deficits may not be
considered large given the current state of falling private sector investment
demand in the economy. A reflection of overall low aggregate demand can be seen
in the declining inflation trend, contraction in the real private sector
credit, and falling volume of imports. The SBP’s monetary policy stance in FY12
so far, a cumulative reduction of 200 basis points, has been largely framed in
this context.
The lack of diversified and sustainable financing sources has resulted in
substantial borrowings from the banking system by the government and declining
foreign exchange reserves. This has squeezed the availability of credit for the
private sector and increased the pressure on rupee liquidity. The SBP has been
providing substantial liquidity on almost permanent basis, on average Rs230
billion during 1st July – 9th February 2012, to ensure smooth functioning of
the payment system and avoid financial instability. The continuation of this
trend, however, carries risks for effectively anchoring inflation expectations
in the medium term.
The uncertain market liquidity flows have lead to excess volatility in short
term interest rates and increased the challenges of monetary management. The
main reasons for this uncertainty include: a sharper deterioration in the
external current account deficit, a declining trend of foreign inflows, and a higher
currency to deposit ratio. However, other market interest rates, such as KIBOR
and Weighted Average Lending Rate (WALR), have largely followed the policy rate
reductions.
A declining interest rate environment together with a relatively better growth in
Large‐scale Manufacturing (LSM) is expected to help the pickup in private
sector credit. The LSM sector grew by 1.5 percent during July‐November, FY12, which is in contrast to an average contraction of 3.1 percent during the same period of
last three years. Moreover, credit to the private sector has expanded by Rs238
billion during 1st July – 3rd February, FY12. However, to assess its likely
path few points need to be kept in mind.
First, given the continuing energy shortages, unfavorable law and order conditions,
and an uncertain political environment, the desired boost in business
confidence and thus private sector credit may not take place. Second,
profitability of the textile sector, a major user of private sector credit, was
better in FY11 due to higher cotton prices. This would facilitate repayments or
keep the demand for fresh credit to a minimum in FY12. Third, the utilization
of installed industrial capacity is considerably low and continues to decline,
which is inhibiting credit demand for fixed investment. Fourth, all of the
fresh credit disbursement in H1‐FY12 was
utilized to meet the working capital requirements, which implies that a
significant part of this credit will be retired in H2‐FY12.
Thus, the full year expansion in
credit to the private sector is expected to remain weak for yet another year in
FY12 despite interest rate reductions. Its year‐on‐year growth is already negative in real terms and indicates depressed
private investment demand in the economy. In addition, given substantial government borrowings from
the 2 scheduled banks together with rising NPLs, banks are likely to continue
to avoid lending to the relatively risky private sector.
According to provisional data, the government has borrowed Rs444 billion from
the banking system, during 1st July – 3rd February, FY12 to finance its current
year’s fiscal deficit. This includes Rs197 billion borrowed from the SBP and
show a year‐on‐year growth of 25.8 percent. Moreover, these borrowings are significantly higher than
the yearly financing requirements of Rs293 billion envisaged in the FY12
budget.
The provisional estimate of fiscal deficit for H1‐FY12, from the financing side, shows a deficit of Rs532 billion or 2.5
percent of GDP. Given
that the fiscal deficit is always higher in the second half of a fiscal year,
by at least 0.5 percent of GDP during the last ten years, containing the FY12
fiscal deficit close to the government’s revised target of 4.7 percent of GDP
would be difficult. Encouragingly, the tax collection by the Federal Board of
Revenue during H1‐FY12, at Rs840
billion, has shown a strong growth of 27.1 percent. Similarly, the announcement
of auction of 3G licenses in the telecommunication sector is a positive
development and could help
in containing the potential fiscal slippage.
However, based on the seasonal pattern of tax collections, the full year target
of Rs1952 billion still seems ambitious. At the same time, there are
indications that the issue of circular debt in the energy sector remains and
losses of major Public Sector Enterprises (PSEs) continue to increase. Thus,
the likelihood of slippages on the expenditure side on account of subsidies,
over and above the budgeted amount, cannot be ruled out. The delay in these
subsidy payments may have implications for resolving the circular debt issue.
The risks to external position have also increased due to worsening terms of
trade, fragile global economic conditions, and continued paucity of financial
inflows. In addition, $1.1 billion are scheduled to be repaid to the IMF in H2‐FY12. The SBP’s foreign exchange reserves have already declined to $12.2
billion as on 9th February 2012 from $14.8 billion at end‐June 2011. Similarly, the rupee‐dollar exchange
rate has depreciated by 5.2
percent in FY12 so far.
Led by 33.7 percent growth in imports of petroleum products on the back of
elevated international oil prices, total imports have increased to $19.7
billion in H1‐FY12. The volume of imports
remained muted, which indicates
moderation in domestic demand pressures. Given the rising tensions in the US‐Iran relations and political uncertainty in the Middle East region, the
oil prices are unlikely to fall significantly in the near future and may even
increase. Therefore, despite
low volumes, imports are projected to grow in the range of 12.5 to 14.5 percent
for FY12.
Similarly, while the falling cotton prices played their part in sharper than
expected slowdown in export receipts, $12 billion in H1‐FY12, the volume of exports have also declined considerably. Assuming that these trends would
continue in H2‐FY12 export receipts are
projected to show a decline of 3 to 5 percent in FY12. Incorporating a steady
flow of workers’ remittances, the external current account deficit is expected to remain in the
range of $3.5 billion to $5.5 billion or 1.5 to 2.4 percent of GDP. The
possibility of limiting the deficit to the lower bound of the range is mainly
contingent upon the realization of Coalition Support Fund, $800 million, and
the proceeds from the auction of 3G licenses, estimated to be around $850 million.
The real challenge is to finance this projected external current account
deficit. The actual net capital and financial inflows during H1‐FY12 was only $167 million due to decline in both the direct and portfolio investments and shortfalls in
official flows. Assuming that all the official flows contemplated by the
government are realized – $500 million from the issuance of euro bonds, $800 million
from the privatization proceeds of PTCL, and budgeted loans 3 from
international financial institutions – the net capital and financial inflows
could increase to $3.8 billion by June 2012.
These fiscal and external developments have resulted in a skewed composition of
monetary aggregates. In particular, the increase in the Net Domestic Asset
(NDA) component of M2 is disproportionally large while the Net Foreign Assets
(NFA) has contracted. Given its strong correlation with inflation, the resulting
increase in the NDA to NFA ratio is not a welcome development. The year‐on‐year growth in M2 for FY12 is projected to be in the range of 12 to 13
percent.
The changing composition of M2 requires a careful interpretation. For instance,
the deterioration in the external sector is mostly due to adverse terms of trade
developments and uncertain official inflows and may not be a sign of rising
aggregate demand. Similarly, the pressure on aggregate demand due to the
government borrowings from the banking system is being partly offset by the
weak private investment demand.
These conjectures are supported by the decline in year‐on‐year CPI inflation to 10.1 percent in January 2012. In addition to
moderation in aggregate demand, this also reflects improvement in domestic
supplies of food items. However,
there are indications of underlying inflationary pressures. For instance, the
number of CPI items showing year‐on‐year inflation of more than 10 percent is significant and mostly belong
to the non‐food category.
The SBP expects the average inflation in FY12 to remain in the range of 11 to 12 percent, which implies an
uptick in inflation in H2‐FY12. The main
reasons for this assessment include: increases in electricity and gas prices,
high international oil prices, impact of exchange rate pass‐through, increase
in support price for the upcoming wheat procurement season, and substantial
government borrowings from the banking system.
For inflation to come down further, the implementation of the Medium Term
Budgetary Framework (MTBF) is imperative. The MTBF envisages a systematic
reduction in the fiscal deficit to 3.0 percent of GDP in FY14 by increasing the
tax to GDP ratio and stipulates inflation targets of 9.5 percent for FY13 and 8
percent for FY14. Decisive reforms in the energy sector can also go a long way
in achieving the MTBF targets. These reforms not only will reduce the government’s
reliance on banking system borrowings but also minimize the need to adjust the
energy prices in a sporadic and unpredictable manner. Both these factors would
help in improving the effectiveness of monetary policy and its contribution in
keeping inflation low and stable.
In conclusion, despite moderate aggregate demand, pressure on rupee liquidity
is likely to continue due to uncertain foreign inflows and substantial
government borrowings to finance the fiscal deficit. Moreover, inflationary
pressures have not eased significantly. It must be emphasized that sustainable
economic recovery over the medium term would call for a sizeable increase in
both the domestic and foreign private investment in the economy. For this to
happen, the business confidence needs to be revived by reducing uncertainties
due to energy shortages. Against this backdrop, the Central Board of Directors
of SBP considers the 200 bps reduction in the policy rate, already introduced
in FY12, to be appropriate and has decided to keep the policy rate unchanged at
12 percent,.
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