Mar 30 - Apr 05, 2009

Is time ripe to cut discount rate to a point that can inject money needed for economic growth? Considering inflation that slid down from a record high in August and October last and that had restrained State bank to further increase discount rate in the Jan-March 2009 monetary statement, this may be possible. Yet, seeing from another dimension of government borrowing which is said to be a most important stimulant of monetary tightening and which continued to rise due to budgetary deficit in the 3rd quarter of this fiscal year, the possibility of loosening monetary circulation in the next policy statement seems to be gloomy. The low growth of broad money (M2) supply until the start of March may lead to downward reversal of policy rate.

Although currency in circulation registered a rise during July-March FY09 over a comparable period last year, up to Rs179.12 billion from Rs177.47 billion, M2 exhibited 2.38 percent growth as opposed to 7.71 percent previously.

Total net government sector borrowings were Rs421.42 billion during 1st July to 7th March, 09 in a wide contrast to Rs299.77 billion during the comparable period FY08. Government heavily tilts towards SBP to fund its financial needs and to shorten budgetary deficit. This promotes central bank to resort to monetary tightening to discourage government from central bank borrowing. During the period under review, out of Rs411.49 billion gross loan for budgetary support, Rs348.43 was sanctioned by the State bank. Scheduled banks loans released the rest.

However, cumulative rise of 500 basis points during 2008 has squeezed enough liquidity from the market to bring stabilization in the economy and IMF's SBA first tranche fulfilled the financing requirement of balance of payment. In addition to this, there are indications of increasing foreign reserves and exchange rate control.

Although budget deficit in the first half of current fiscal year of Rs250 billion was shortened by central bank funds, phasing out of subsides provides government with a means to slash borrowing. The subsidies removal and decline in international commodity prices should have brought rationalization in spending, but rise in government borrowing in almost nine months of FY09 showed contrast outcomes. Nor decline in prices of petroleum products reflected in decrease of CPI inflation that has monstrously mounted to 23.49 percent in July-Feb FY09 from 8.9 percent in the corresponding period FY08 and 8.04 per cent in FY07.

In past, these two had been resulting in fiscal deficit. According to SBP, government spent Rs395 billion on subsidies during FY08. Similarly, exchange rate disparity or depreciation of PKR against USD brought about worst impact on balance of trade, elevating import growth influenced with high commodity prices. However, import growth plunged from 31.2 percent in FY08 to 15.4 percent in H1FY09, it says. Unpredictable fall in prices of petroleum products helped government to control unabated import growth, which was widening trade deficit.

In addition to this, intervention by central bank in currency market calmed down import growth. While Pak rupee has gained stability in its value over dollar in effect, overall inflation still requires administrative corrections. It is relevant to recall comments of governor State bank, reportedly expressing inability of administration in controlling exchange rate disparity and inflation at the same time.

However, from an above 24 percent in August 2008, the year on year inflation started to slide downward by end of first half of current fiscal year. YoY trimmed core inflation remained at 21 percent when inflation was at its peak while it was 21.7 percent in October 2008 and finally came down to 20.8 percent in February 2009, although non-food and non-energy core inflation did not exhibit downward trend during the same span.

Worldwide, excess of money supply is attributed a main force behind price spike (inflation) and rising interest rate is considered panacea to constrict money supply. Last time, State bank pulled policy rate from 13 to 15 percent on 12th November 2008 in the interim policy announcement to mitigate risks of liquidity outflow and to introduce macro economic stability. That whether the liquidity management measures taken by the central bank was effective to put the economy back on the path of stability demands 'restrained optimism' according to SBP that mentioned in the monetary statement other structural weaknesses inhibit guard lifting at this stage despite positive signs.

While high interest rate diverted government sector funding from central bank to an extent and increased auctions of T-bills, it simultaneously added up cost of lending for private sector. During the nine month of current fiscal year, credit to private sector totalled around Rs111.45 billion as opposed to Rs292.22 billion in the comparable period last fiscal. State bank ascribed different reasons to decrease in credit to private sector, saying banks were reluctant to disburse credit to private sector during the period and instead enthusiastic in participation in auctions of T-bills.

While there might be many reasons behind this reluctance, non-performing loans remained one that prompted banks consciousness. The participation of banks in six auctions held since announcement of interim policy measures gathered substantial liquidity for government that according to SBP helped government to meet end-December targets under SBA. Government gathered Rs482 billion against the maturities of Rs321 billion through these auctions.

While there are some positive signs of recovery of macro economic indicators that may allow decrease in discount rate, monetary aggregates may prove obstacles in the way of downward spiral. Recent SBP data reveals that during 1st July to 7th March FY09, broad money supply is not as high as was in the previous year. In spite of this, two negative signs 1) drastic fall in net foreign assets 2) despite decline in growth of net domestic assets-inflation propellant- registering 10.06 percent growth down from 17.09 percent, rise in government borrowing may make discount rate downward revision imprudent.