FACETS OF MONETARY POLICY

THE CENTRAL BANK MUST EASE MONETARY POLICY FOR CREATING NEW PRODUCTIVE FACILITIES AND PRODUCING EXPORTABLE SURPLUS

SHABBIR H.KAZMI
Jan 28 - Feb 03, 2008

The government has been following rather strict monetary policy to contain inflation in the country. In this attempt interest rate has been going up across the board. The lending on Kibor plus has touched a level that the delinquent loans are on the rise.

As the world faces recession central banks across the globe are following a policy to cut down interest rates. The largest and historic cut has been announced by the Fed in the USA. Though, the sub prime loans problem has least relevance with the world, the impression is being created that if the US goes into recession it would also impair other countries.

A lot has been written and talked about the causes of inflation in Pakistan, eroding competitiveness of the local exporters and shrinking purchasing power of the people. Discussing the problem would not resolve the issues but a quick recap may help in coming up with prudent solutions.

First of all it necessary to point out that State Bank of Pakistan releases Monetary Policy Statement at after every six months or twice during a financial year. The second half of current financial year has commenced from 2nd January 2008 but the statement has not come as yet. It is expected to be announced on 31st January.

ECONOMIC REVIEW: A review of the performance of the economy for the last couple of years clearly indicates that the hike in interest rates, as a measure to contain inflation, has failed in delivering the desired results, rather the hike has adversely affected fresh investment in the country. It is also evident that that lending on Kibor plus basis has impaired consumer finance. Number of delinquent loans is on the rise, at present the largest number of such loans pertains to auto finance but housing finance is also getting infected.

There is ample evidences that advances to deposit ratio is on the decline, which should be a cause of concern for the commercial banks as well as the central bank. However, banking sectors analysts say that advances are on the rise and the apparent decline in ratio is due to higher growth in deposits compared to advances. However, it is a very weak argument because if the deposits are increasing there has to a corresponding increase in advances.

Analysts attribute slower growth in advance to shift in focus of banks from lending to investing in government securities. Record inflow of remittances has jacked up deposits any banks find it much easier and secure to invest in the government securities rather than lending to the private sector.

Despite increase in interest rates credit disbursement to agriculture sector increased 26% during the first half of the current fiscal financial year and most of it was distributed by five major commercial banks. According to the central bank disbursement of credit to agriculture sector by commercial and specialized banks shows an impressive growth of about 26YoY during this period.

According to the details these institutions disbursed more than Rs 90 billion to the agriculture sector during this period as compared a little less than Rs 72 billion during the same period last year. Overall credit disbursement by Allied Bank, Habib Bank Limited, MCB Bank, National Bank of Pakistan and United Bank stood amounted about Rs 45 billion.

Incidentally, government’s appetite for funds has been growing due to a number of factors from rising budget deficit to unplanned expenditure due to deteriorating law and order situation. The immediate fall out is that the government is started cutting down expenditures pertaining to Public Sector Development Program.

According to the central bank disbursements under export refinance scheme has increased despite introduction of a new system from this year. It was apprehended that disbursement under the new arrangement may decline. However, many textile sector experts allege that the borrowed amount is being diverted to other sectors. The common complaint is that textile companies are investing large sums in cement and other industries. This is resulting in gradual contraction of textile industry.

LIQUIDITY CRUNCH: Some sector analysts are of the opinion that commercial banks have been forced to approach discount window of the SBP due to liquidity crunch. However, others are of the view that there is ample liquidity in the banking system but banks prefer to lock their funds for longer duration, evident from results of Treasury Bills auction. In the recent past banks abstained from submitting bids for 3-month bills. The participation bench mark 6-month bills has also gone down substantially and bulk of the bids were for 12-month papers.

Anticipating economic slowdown central banks of most of the countries are trying to bring down lending rates and Pakistan should not opt for contrary. To accelerate GDP growth rate and boost exports interest rates have to be brought down. The sooner it is done the better it will be.

Over the years and despite tight monetary policy inflation has not been contained. It is evident from skyrocketing prices of every item in general and price of food items in particular. Purchasing power of people is eroding at a very fast rate despite rising in per capita income.

It is on record that hike in prices in not due to imbalance in demand and supply equation. The highest increase has been registered in the prices of food items, which have inelastic demand. Price of wheat flour has busted all the previous records.

There are many factors responsible for the hike of flour prices from incorrect crop estimation to porous border facilitating wheat smuggling and government facilitating export of wheat at US$ 250/ton and subsequently importing the same at US$ 500/ton. The consistent pressure on food prices is increasing the threat of second round of inflation. Additionally, rising soft commodity prices are expected to keep domestic demand robust.

The central bank has not announced Monetary Policy Statement as yet. It is therefore, suggested to ease the policy for the creation of new productive facilities to overcome unemployment and produce exportable surplus.