A MONETARY POLICY SANS IMF DIKTAT
Oct 17 - 23, 2011
The reduction of 150 basis points in the benchmark interest rate by the central bank came as a big surprise to many market analysts. The central bank's monetary policy for October-November was a departure from its previous policy of monetary tightening that was pursued over the past few years. The reason was simple. The government increased the discount rate as it was committed with International Monetary Fund (IMF) under a $11.3 billion bailout deal agreed to in 2008. The government maintained high interest rate under IMF diktat. The situation has now changed after the economic managers in Islamabad decided to seek no more loan programs from the Washington-based lender after ending the loan program on September 30. Giving its first independent monetary policy, the central bank cut the discount rate by 150 basis points to 12 per cent from 13.5 percent. It was the second rate cut in the current fiscal year 2011-12 after Acting Governor of State Bank of Pakistan (SBP) Yaseen Anwar unexpectedly slashed discount rate on July 30 by 50 basis points to 13.5 percent.
The rationale the central bank has given for huge rate cut is the lower Consumer price index (CPI) inflation and the government borrowing. CPI inflation rose 10.46 percent in September from a year earlier, while the government borrowing from the central bank was Rs1,051 billion on September 30, lower than the agreed limit of Rs1,155 billion for the current fiscal year 2011-12. The analysts however argue that the inflation in the country is cost push inflation, which is driven by high oil prices and has hardly any connection with the interest rate. It is a fact that the double-digit interest rate has been unable to control double-digit inflation, which has become a serious problem for the country with surging poverty levels.
Under IMF pressure, the government maintained one of the world's highest benchmark interest rates, in an economy hurt by inflation, terrorism and falling foreign investment. High interest rate held back growth and decelerated economic activity. The country's monetary policy has so far been under heavy burden of borrowed $11.3 billion from IMF in the shape of Standby Agreement and policy-makers were bound to consider reservations shown by the IMF at different occasions. The hike in interest rate acts as an upshot to inflation and prices of consumer goods multiply owing to increased cost of manufacturing and doing business. Tight monetary policy dealt a severe blow to the ailing industry bringing the industries on the verge of collapse.
The government expects an economic growth at 4.2 percent in the current fiscal year, compared to 2.4 percent growth in the last fiscal year, one of the lowest growth in the past decade.
"Pakistan needs to fire on all cylinders to support growth," Bloomberg reported Farid Aliani, a Karachi-based analyst at BMA Capital Ltd. as saying. "Easing monetary policy would help."
Market analysts believe that the central bank's move is likely to spur a rally in the stock market, but it is unlikely that the rate cut would stimulate investment activity, which is affected because of the worst power crisis and growing security concerns in the country.
It is a fact that Pakistani stocks witnessed significant surge, as the rate cut boosted investors' confidence. The benchmark Karachi Stock Exchange (KSE)-100 index on october10 gained 300.16 points, or 2.5 per cent, to close at 12,154.00.
"The cut in the interest rate was phenomenal, which has boosted the market and thrilled investors," AFP reported Mohammad Sohail of Topline Securities as saying. "This cut shows the central bank's focus is on economic growth," he said.
Business community has welcomed the central bank's move, which will provide some relief to the ailing industry. The tight monetary policy has not allowed the private sector to play its key part as engine of growth. Pakistan has so far been on its way to becoming one of the most expensive countries of the world. The huge rate cut has at least changed the way, though interest rate at 12 percent is still high and it must be reduced to single-digit. The increased interest rate has not only made doing business increasingly expensive but also marginalized the private sector.
High borrowing costs discouraged the demand for private sector credit, which in turn decreased private investment adversely affecting the prospects of economic growth. Foreign direct investment in the country fell 40 percent to $112.4 million in the first two months of the fiscal year that started July 1 from a year earlier. The country has failed to effect improvement in foreign investment due to poor law and order situation and negative economic indicators.
The country's economy has so far witnessed low economic growth and double-digit inflation - the classical characteristics of an economy in stagflation. The increase in interest rate increased interest payments on government debt, causing an even higher fiscal deficit, despite higher profits of the central bank. Poverty ratio in the country is rapidly rising due to economic slowdown, high inflation and reduction in subsidies. The prevailing level of poverty incidence in the country will further deteriorate as a result of recent floods, which has adversely affected livelihood, especially of rural population, along with huge damage to property, agriculture land, and infrastructure.
The central bank actually tightened its monetary stance due to less liquidity in the market created by the increased government's borrowing. The government's inability to control its increased borrowing for current expenditure may push the country into a prolonged spell of stagflation. The easy recourse to increased borrowings from the banking system leaves little incentive to the government to put its badly needed fiscal situation in order.
The government borrowing from scheduled bank grew by 74.5 percent last year that contributed 65 percent to the 15.9 percent growth in broad money (M2), according to the central bank. The drop in private sector credit was only four percent. As a result of the drop in tax-to-GDP ratio to 8.6 percent, the fiscal deficit for the last fiscal year is estimated at 6.2 percent of the GDP. The country's foreign and domestic debts witnessed an alarming growth in the last fiscal year 2010-11. The payable foreign debts currently stand at the level of $60 billion including $8.97 billion loan of the IMF.