June 02 - 08, 2008

The mounting aggregate demand of credit from private sector in the just enfolded fiscal year exhibited a decadal growth rate that outpaced last three decades annualized growths, indicating towards tough time government may face in the budding fiscal year to control spiking demand pressure and to strike balance between economic growth and price stability.

While State Bank of Pakistan seems to like monetary tightening measure for calling back liquidity from the market to tame the turbulent food inflation that crosses beyond 20% as well as headline inflation that reaches 17.2% at the same time it sets to induct the circulated money back into the financial intermediation process for meeting the credit requirement of the economy. Although the induction manifests in future policy currently containment of money supply is becoming difficult as soon as skyrocketed inflation increases urgency of working capital to meet the unabated cost of doing business.

The enormous domestic demand of borrowing has expanded money supply in the market. Along with other practicing controlling tools of money supply such as raise in cash reserve requirements, State bank has again recently increased the discount rate by 150 bps to 12%. This was the fifth consecutive increase since April 2005. This policy aimed at to discourage fiscal profligacy to some extent has reduced the disparity between nominal and real interest rate. But, historically policy rate increase has not quashed away yawning differential owing to run-up inflation.

Nonetheless lending rate goes up alongside bps hike, in real term real lending rate lowers down following subtraction of high inflation rate. It is the real interest rate that determines spending tendency in the economy. In a subsequent effect of speeding inflation, real interest rates were fallen from 3.4 percent in December to a titillating 1.9 percent in March 2008. In fact, borrowers in Pakistan have been experiencing low real lending rate for years. The high inflation corrodes advantage of low interest rate.

State bank accounts drawdown of lending rate for one of the stimuli behind the progress in private sector credit, which has been moving at a slower growth rate till January 2008 when compared to previous year, however, incredibly caught its speed following the upward revision of policy rate in February 2008.

Diluting the impact of tight monetary stance of State bank, credit accumulation in both government and non-government sectors during July-May FY08 continued steadily registering Rs. 837.4 billion receipts. This was a year on year growth of around 24% for that period of the fiscal year while during the same period of FY07 growth rate was of 18.4% and credit accumulation of Rs. 459.8 billion. Credit of non-government sector including private and public sector organizations during July-May08 accounted for Rs. 414.4 billion while government sector debt financing registered a phenomenal growth of 32% with a total amount of Rs. 423 billion according to State bank statistics.

It is noteworthy to mention that year-on-year domestic credit growth has outpaced results of three decades. The enormous demand of credit has signified importance of debt financing for operational activities of commercial organizations. Apparently the demand of credit in textile sector, which is not performing up to the mark, kept on increasing during the financial year. Growth of textile and garments industry, which has been the mainstay of the national economy, hit snags for enumerable reasons. In addition to its great contribution in manufacturing and thus in gross national products and in increasing employability of the population, textile and garments industry is still enjoying the competitive advantage in international market. The group of textile and garments and its derivatives hold biggest share of manufacturing in the country as well as in exports, contributing 10.5 percent to GDP, 68 percent to exports and employing over 38 percent of all industrial workers. In recent past, exports of the industry to compatible USA and EU market had significantly decreased due to operational deficiency caused by power crisis and most importantly financial constraints.

Besides, refineries and power remained two of major debt aspiring sectors. Due to high prices of inputs in domestic and international market and rising cost of fixed investments, these sectors persistently were looking for running finances (working capital) from commercial banks. Not only cost of gasoline is showing an uptrend of high rise but allied industrial products such as large scale machineries have too become price sensitive.

Imported products cost, extensively spurred by rise in oil prices, significantly jacked up import bill. Non-food and non-oil imports contributed above 40% in the import bill of FY08. Surging in rates of domestic petroleum products has become a direct proportional to upward revision in international crude price even though indigenous oil production can only fulfill about 30% national energy demand and import plugs residual demand gap.

Many counties have recently experienced turmoil like situations due to uncontrollable inflations. Businesses are affected by any kind of abnormal price behavior that affects directly on production cost. Moreover, decrease in real interest rate persuaded many private importers who used to distance themselves from bank finance. There are several importers whose absolutely private investments in their businesses keep their operations limited while working finance provides an expansion option.

Comprehensively, private sector credit growth was accelerated due to shortage of finance. Financial assistance of banks are prerequisites to sustain the business and ultimately to expedite the economic growth. Suitable lending rate on finance means minimum cost of production even if to a certain level debt financing is to give sustenance to trade and industry. Policy encouraging real interest rate increase may be beneficial to reduce the inflation rate, however, for it measures directly suppressing the inflation may winningly be effective. Indirect rather than direct squeezing technique to tame inflation has not produced desired outcomes in recent past. Fiscal and monetary tightening may loose its application in case of rising inflation.