UNDISCOUNTED DISCOUNT RATE
SHABBIR H. KAZMI (email@example.com)
Feb 15 - 21, 2010
State Bank of Pakistan (SBP) has cited looming inflationary pressure one of the reasons for keeping discount rate unchanged. Similarly, ministry of finance seems to catch up with fiscal deficit of 5.3% against earlier fixed target of 4.9%.
Being under the IMF program the government is not likely to provide any fiscal incentives to the manufacturing sector. The only hope for the time being is the release of funds by the Friends of Democratic Pakistan (FoDP) and Coalition Support related funds, besides further external debts.
The CPI inflation for January 2010 has reached 13% YoY. This would be 8-month high inflation, and likely to take 7MFY10 average to close to 11%. The main reason for the surge in YoY CPI inflation for January was the surge in fuel and energy prices because of withdrawal of subsidies on electricity and gas. Reportedly SPI-based inflation has averaged above 18% YoY for the last four weeks. This was the result of a combination of 12% increase in electricity prices, 18% increase in gas prices, and up to 9% increase in petroleum product prices implemented beginning February.
However, one of the factors likely to contain hike in cost of energy products is the expectation that crude oil prices may remain stable for the remainder of the fiscal year.
The two points of serious concern are volatile inter-bank market and growing difference between inter-bank and open market exchange rate. Lately, rupee has been losing its value against the US$ and other major currencies. Reportedly, rupee has lost 2.5% value since beginning of the calendar year in the open market. The much-needed support in the form of FoDP funds has not arrived causing relentless pressure on the rupee.
REACTION OF THE BUSINESS COMMUNITY
For years Pakistan has been following tight monetary policy to curb inflation. However, when India faced higher inflation its central bank immediately raised the cash reserve ratio (CRR), which yielded immediate results. As against this, in the past the central bank of Pakistan reduced the CRR but increased the discount rate in an attempt to contain inflation, but the decision failed in achieving the desired objective.
The gulf between the central bank and the business community seems to be further widening on the issue of policy. In a rather unusual tone, Sultan Ahmed Chawla, President Federation of Pakistan Chambers of Commerce and Industry (FPCCI) has criticized the central bank for keeping the policy rate unchanged at 12.5%.
Speaking at a press conference on Thursday, Chawla expressed reservations of the business community about the policies being followed by the central bank and termed these extremely unfavorable. He said high discount rate would keep the cost of bank borrowing high for the trade and industry. "This way the traders will refrain from borrowing to expand their businesses and further erosion will aggravate the weakening businesses of the country," he said.
Reportedly, output of the manufacturing sector declined 20% during financial year 2009 and rose about half percent during July-September. Outputs of most of the industries remained significantly below the level achieved two years ago, he added.
Referring to the neighboring countries, he said, the discount rates were much lower: 4% in India, 5.5% in China, and 6.5% in Bangladesh. India is likely to achieve around 8% GDP rate this year.
Chawla said according to the SBP's stance this high interest rate was aimed at controlling inflation. In Pakistan inflation is not a demand-pull phenomenon and constraining effective demand has a disastrous effect on macroeconomic growth, pattern of income, and asset distribution. He also said that the SBP was ineffective in controlling inflation.
Labeling it an anti-investment policy, he lamented SBP's policy was not independent rather designed under the diktats of the IMF, which is detrimental to the businesses of the country. Despite availability of resources and a great potential, Pakistan's economy was in a strict crunch because of high interest rates, high costs of energy, and the policy of doing away with subsidies by the government.
Apparent breach among the coalition partners (PPP, PML-N and MQM) is weakening the present government's ability to withstand the external pressures. Iran has successfully averted the external pressure because its people stand united. Its enemies planning to stage huge anti government demonstrations on the anniversary of Islamic Revolution failed in bringing people on street. Though the opposition leaders are critical of the present regime, yet they are not willing to compromise on the issue of enrichment fuel for atomic reactors.
The decision making capacity of the present regime is questioned at this moment. Many of the decisions have attracted severe criticism. Running thermal plants at lower capacity to contain rising circular debt and keeping interest rate high to bring down inflation in the country are termed imprudent. If the investors are convinced that decision making is irrational the government should not expect any fresh investment.
For the benefit of those who still do not know the factors ailing the economy, few factors are highlighted: 1) precarious law & order situation, 2) economy highly vulnerable to inflationary pressures and depreciating Pak rupee and 3) high interest rate. Rift between the government and the judiciary is marring the performance of the present coalition government.
While some of the experts are talking about the silver lining on the geopolitical front, yet public term it hallucination. The points most talked about are 1) India expressing its willingness to commence dialogue and 2) Pakistan army achieving substantial success in weeding out the foreign militants. Since India is not inclined to talk about the core issue Kashmir and its intentions are clear regarding construction of dams on River Chenab, the dialogue offer can be termed a hoax call.