THE NEED TO REDUCE GOVT. BORROWING

SAAD ANWAR HASHMI
(feedback@pgeconomist.com)

Oct 8 - 14, 20
12

The Monetary Policy decisions by SBP has always remained under speculation whether the rate will increase or decrease considering the macro economic indicators particularly inflation. SBP recently announced a reduction in interest rate by 150 bps and is expected to announce another reduction in interest rates by 50 bps to 100 bps which would reduce the interest rate possibly below 10 percent. International oil prices continue to be volatile and not expected to be maintained below US Dollar 100 per barrel over a long term horizon since high oil prices translates into higher GDP of OPEC. Pakistan has witnessed consistent revisions in oil prices as the Government uses this tool for revenue generation in the form of tax. One of the core reasons is SBP is government borrowing which have yet to be reduced. If oil prices decrease, any such decrease will be negated through the devaluation of rupee against the dollar which is likely to increase the import bill and causing inflation. CPI as on July 2012 stood at 9.60% with electricity, fuel and gas accounting for 29 percent of the CPI. This is the first time during CY12 that CPI is witnessed in single digits.

The decline in interest rate will impact the bottom line of the bank mainly Interest income which may potentially reduce if the current banking portfolio remains intact and additional disbursements are not made. Profitability may only increase if both consumer and corporate advances increase to encourage lending. Banks on the other hand to maintain the top line growth are expected to increase the margin over benchmark rate and nullify the impact of declining rates on their balance sheet. Additionally since rate on advances have witnessed a decline, banks will also reduce cost of deposits through reduction in rates offered on liability accounts. It is also expected that with declining interest rates, banks would eventually discourage long term deposits and will only issue against rates which would be unattractive for the depositors.

The new Monetary Policy decision, has also reduced T-Bill yield offered between 10.2 percent and 10.3 percent which is still attractive for the banks. If banks do not increase disbursements and the government will continue borrowing from the banking sector, the reduction in rates is less likely to bring about any impact since lending practices of banks will be under status quo. SBP in light of lowering of inflation has given an incentive to the economy to boost the private sector through expansion of credit with hopes to increase production and GDP growth. A source for liquidity pressures in the economy is sluggish economic growth and foreign direct investments which could substitute low tax base. SBP has stressed time and again that the government must devise fiscal reforms and plan foreign financial inflows to mitigate uncertainty and pressure on reserves and cushion the budgetary deficit.

During the period of FY12, GDP was recorded at 4.7 percent. The GDP growth rate is slow and ideally would have expected to be around 6 percent if the economy was not hampered with instability. There is immense potential in the market for long term investments, however, the reduction in the policy rate reduction will show results in the next six months whether advances have been increased through reduction in rate. With a poor tax base and imports double of exports, the only major source of funding for the government is borrowing from the private sector, outstanding stock level reaching of Rs. 1,660 billion. The year-on-year growth in the private sector credit was only 4.2 percent.

According to SBP, the reason for decline in private sector credit is electricity and gas shortages, security conditions, and political environment. Under these circumstances banks were discouraged to lend based on the risk involved whereas manufacturing concerns avoided expansion projects. The challenge for SBP with the Monetary Policy is to reduce inflation and encourage private sector lending alongside an attractive rate of return for depositors to counter rise in inflation. The Monetary Policy cannot work in isolation considering external shocks e.g. international oil prices, recessionary impact, devaluation in interest rates or government borrowings. Pakistan is a net importer therefore any devaluation in the exchange rate against the dollar will make imports expensive and put further pressure on the reserves. Though exports due to such devaluation are expected to grow, however considering rise in input cost, such differential may be negated making prices unattractive for the export markets. Decline in interest rate is expected to stimulate the economy and improve GDP through enhance production levels. This will only be achievable if economy provides conducive environment for business growth not hampered through power shortage, gas curtailment, law and order issues along with political environment. Additionally if the government does not stop borrowing form the private sector and increases off take through T-Bill auctions, fresh advances will be slow.

An encouraging sign for the economy are worker remittance which average more than USD 1 billion each month, however FDI has decreased and expected to be less than USD 1 billion at the close of the year keeping with political uncertainty and law and order issues. The country recorded worker remittances of US Dollar 13.2 billion in FY12 as compared to US Dollar 11.2 billion in FY11 seen as a positive sign. It is expected that the inflow of worker remittances will reach USD 15 billion by FY13 through the Pakistan Remittance Initiative (PRI) scheme recently launched. Foreign investors take a strict view on Pakistan keeping into account the country risk, therefore, if domestic investors are hesitant with investments, it is unlikely that foreign investments would flow.

In order to curtail inflation and finance government budgetary deficits, SBP's decision on the monetary policy alone cannot work in isolation unless such policies work hand in hand with fiscal decisions to increase tax base and eliminate transactions which run parallel to the economy. The government's total expenditure to GDP is 19 percent whereas revenue to GDP is 12.5 percent creating a mismatch which needs to be filled through tax base rather than borrowing from the banking sector. Though decisions to maneuver the economy also rests in the hand of the government, what will eventually help resolve the situation is high degree of integrity and accountability for public so that the government is less reliant on the banking sector. If government pulls back on borrowings from the banking system, banks will automatically lend to help maintain the bottom line and profitability. We can only expect that declining interest rates would assist in GDP growth, create employment and give wider access to the public through bank advances.