HIGH INFLATION & LOW ECONOMIC GROWTH

SYED FAZL-E-HAIDER
(feedback@pgeconomist.com)

June 18 - 24, 20
12

Pakistan's central bank kept the benchmark interest rate unchanged at 12 per cent, as the country faces double-digit inflation despite a sluggish economic growth. The State Bank of Pakistan (SBP) in its monetary policy statement released on June 8, 2012 warned the government against its excessive borrowings from banks, which have reached the alarming level. The government borrowed Rs1,097 billion from the banking system for budgetary support as of May 25 from July 1, 2011, while it borrowed Rs414 billion directly from the central bank during the period.

The country's central bank has so far been unable to check the inflation-fueling government borrowings, though it has issued several warnings that fell on deaf ears. The government increased its direct borrowing from the central bank, printing money to cover the budget deficit, instead of raising taxes. The country's central bank for the fourth time kept its key policy rate unchanged since cutting it by 150 basis points to 12 per cent on October 8, 2011. The analysts believe that fears of higher inflation mainly because of government's excessive borrowing from banking system forced the central bank to leave its benchmark interest rate unchanged.

The consumer price index (CPI) inflation in May increased by 12.3 per cent compared to 11.3 per cent in the previous month and 12.6 per cent in the corresponding month of last year, according to the Pakistan Bureau of Statistics (PBS).

"Inflation expectations cannot be effectively anchored around single-digit targets without limiting fiscal borrowings from the banking system, particularly from the SBP," said SBP's monetary policy statement.

The country's economy witnessed a slowdown as it grew by 3.7 per cent, against the growth target of 4.2 per cent set for the current fiscal year 2011-12, which will end on June 30. The central bank has projected high inflation outlook for the next fiscal year 2012-13, starting from July 1, due to incessant government borrowing from the domestic sources and widening of the budget deficit amid lack of inflows. The burden of financing the deficit is likely to fall on the banking system.

Finance Minister Abdul Hafeez Shaikh claimed that the government was able to curtail inflation bringing it down to 10.8 per cent in the first 10 months of the current fiscal year as compared to the 13.8 per cent in the previous year.

Critics however say that 12 per cent is a revised target set for the outgoing year and the government has actually missed the original inflation target of 9.5 per cent set for the current fiscal year. The inflation also remained in double-digits for the consecutive fifth year.

The government's borrowing from the banking system has witnessed a quantum jump of 98 per cent owing to massive expenses in the election year. The country's public debt rose 12.3 per cent to Rs1.3 trillion in nine months of the outgoing fiscal year compared to the corresponding period of last year.

The uninterrupted borrowing from central bank and scheduled banks has already caused an expansionist monetary growth and increased currency in circulation, which has accelerated inflation making it difficult for the economic managers to control the fiscal deficit

"The total expansion of currency is higher than ever, so it is already reaching dangerous levels. It has to be arrested by drastic remedial measures," AFP reported Sartaj Aziz, former finance minister and vice chancellor of Beaconhouse National University, as saying.

The government is involved in higher borrowing from scheduled banks than the central bank, which injects money at around 12 per cent through open market operations, while the government borrows the same at higher interest rates from large banks, whose profits rose by 27 per cent last year.

The Prime Minister Yousuf Raza Gilani-led coalition government's fifth budget presented on June 1 has estimated an expenditure of Rs2.960 trillion with an overall budget deficit of Rs1.105 trillion or 4.7 per cent of GDP for the next fiscal year. The budget deficit for the outgoing year is estimated at 7.4 per cent of GDP, which means the government has missed its revised fiscal deficit target of 4.7 per cent of GDP. The experts believe that a deficit budget is bound to fuel inflation, as the government to meet the deficit would resort to borrowing, which would push up inflation.

Budget deficit widened due to a slowdown in aid flows and foreign investment. Foreign direct investment (FDI) in the country registered a decline of 64.7 per cent to $563.3 million in 10 months of the current financial year as against $1.031 billion in the corresponding period of previous financial year.

The US has withheld payments on the account of coalition support fund (CSF) amounting to $800 million for current fiscal year linking it to resumption of Nato supplies through Pakistan to Afghanistan. Nato supplies were blocked following a cross-border Nato air attack on Pakistan army post that killed 24 Pakistani soldiers in November last year.

Addressing a post-budget briefing, Shaikh did not rule out on June 2 the possibility of seeking a fresh bailout package from the international monetary fund (IMF) in six months. The country has repaid $1.2 billion to the IMF this year, while $2.3 billion foreign debt will be repaid in the next fiscal year.

The budget document says, "Balance of payments will remain under pressure due to external debt repayments to the IMF, declining trend of export quantum, rising international oil prices and weak financial inflows."

The country's current account deficit continues to widen keeping the rupee under pressure. The current account deficit has widened to $3.394 billion in the first 10 months (July to April) of the current fiscal year ending on June 30 as against surplus of $466 million in the corresponding period last fiscal year. A likely balance of payments situation will add pressure to the weakening rupee.

In 2008, the country agreed to $11.3 billion loan with the IMF to avert a balance of payments crisis. It received $7.6 billion but failed to get the remaining $3.7 billion due to slippages in performance criteria, leading to suspension of the programme in May 2010. The programme was extended in December 2010 for nine months, but disbursements were not resumed owing to the government's failure to take fiscal measures as demanded by the Fund.