Lately, Pakistan has been facing two key issues,
depreciating rupee against dollar and rising inflation. Both the factors
are expected to have a negative impact on the economy. The recently
announced policy statement aims at overcoming the twin problems with the
least disruption in economic activities. However, the point to be
remembered that the interest rate movement in Pakistan will be more or
less similar to the interest rate movement in the USA.
According to a report from AKD Securities,
"Pakistan has been maintaining a crawling peg with the US dollar
since 2001 and as a consequence our monetary policy has to roughly
mirror policy in the US. Recently, the Fed has started tightening its
monetary policy and has raised interest rates by 25 basis points.
Consequently, the Monetary Statement of SBP has indicated that it will
maintain a differential with international rates, primarily US T-Bill
Over the last few months, the rupee has started to
depreciate against the US dollar. The decline has been due to
deterioration in Balance of Payment (BoP), mainly caused by a worsening
of the trade balance. Increase in imports of machinery, rise in oil
prices and the end of Saudi Oil Facility increased the demand for
dollar. The BoP position was also adversely affected by the increase in
services account deficit and capital account deficit. Remittances also
recorded a decline.
In the monetary policy statement issued for the first
half of 2004-05, the State Bank of Pakistan (SBP) has indicated at a
"measured tightening of monetary policy" to ensure that the
current growth and investment momentum is maintained and inflation is
controlled. The central bank expects that consumer inflation is likely
to behave normally in the current fiscal year in contrast to the rapid
increase in inflation in the last year where inflation settled at 4.57%
thereby crossing the revised target of 3.8-4.2% set for 2003-04.
Given the substantial monetary expansion during the
last fiscal year amounting to 17.6%, as compared to the target of 11.1%,
the SBP intends to pursue a measured tightening of the monetary policy
with the monetary expansion targeted at 11.4%. It is believed that the
tremendous growth in the Net Domestic Assets (NDA) of the banking system
of 225% in 2003-04 over the target of Rs 100 billion has been taken into
account by the SBP, evident from the NDA targets set for 2004-05. The
NDA target for 2004-05 has been set at Rs. 250 billion, versus the
actual figure of Rs 325 billion for 2003-04, on the back of an expected
increase in private sector credit to Rs 200 billion. Moreover, the SBP
expects that consumer inflation is likely to behave normally, and to
remain within the target of 5% set for 2004-05.
The central bank has also highlighted a few threats
for the current fiscal year, particularly, the need to match foreign
interest rate hikes, an increase in asset prices and worsening of the
trade balance. On the brighter side, it expects the fiscal deficit to
remain at 4% of GDP, a lowering of inflationary pressure from capital
inflows and a reduction in cotton prices during the coming year.
Additionally, the SBP foresees decreased pressure on private sector
credit due to reduced capital expenditure, particularly by the textile
sector. Moreover, the SBP has again indicated that it does not intend to
pursue an aggressive tightening of the monetary policy to prevent
stifling of economic growth. The SBP has also asserted that the rise in
rates will be gradual to prevent stifling of economic growth. Overall,
the main intent of the policy is to ensure adequate availability of bank
credit to the private sector while keeping inflation in check.
The SBP has correctly pointed out that changes in
various macro factors have considerably altered the economy's risk
scenario since the release of the last policy statement. Key negative
changes highlighted by the SBP are: 1)
Hikes in international interest rates will have to be followed by an
increase in local rates to ensure that the gap between the two does not
widen too much. 2)
Continued strong demand for imports is likely to further deteriorate the
trade balance during the current year. 3)
Private sector credit is anticipated to grow at a fast pace in 2004-05
as well, albeit at a slower pace than that in 2003-04 and 4)
Adjustments in wages and a rise in asset prices are likely to exert
further pressure on inflation.
On the brighter side, the SBP foresees the following
positive developments: 1)
Fiscal deficit is likely to remain at 4% of GDP along with an
improvement in financial balances of public sector enterprises. 2)
Lower capital inflows are expected to reduce monetary growth. 3)
Cotton prices are likely to witness a fall in the current year. 4)
A decline in capital expenditure, particularly in the textile sector,
should relieve some pressure on private sector credit growth and 5)
Import of wheat should help stabilize prices of wheat flour.
GROWTH VS INFLATION
In light of the above mentioned factors, the SBP
feels the biggest threats are posed by rising prices and a change in the
value of the rupee. These factors are a consequence of the monetary
expansion witnessed in the last two years. Having said that, the central
bank has also made it amply clear that it feels that an aggressive shift
in policy could slowdown the growth and investment momentum in the
economy. Moreover, it also emphasizes the fact that the labor market
suffers from a high degree of unemployment and a rapid shift in stance
is likely to worsen this situation.
CREDIT PLAN 2004-05
The National Credit Consultative Council has also
released the Credit Plan for 2004-05. The plan targets monetary
expansion of 11.6% or Rs 280 billion. The growth is based on Net Foreign
Asset growth of Rs 30 billion and Net Domestic Asset growth of Rs 250
billion. The main driver of growth is anticipated to be private sector
credit, which is predicted to reach Rs 200 billion. The government
intends to borrow Rs 50 billion, while the Agriculture Credit Advisory
Committee has suggested a target of Rs 85 billion for the agri sector.
PRIVATE SECTOR CREDIT
Similar to the case for 2003-04, the main source of
growth in money supply is anticipated to be private sector credit during
the current fiscal year. The SBP expects it to stand at Rs 200 billion
in 2004-05 as opposed to Rs 300 billion for the previous year. The lower
growth target for the current financial year is a natural consequence of
increasing interest rates and the fact that the initial growth spurt in
consumer financing has passed. Moreover, the industrial sector took
considerable advantage of low interest rates and borrowed heavily during
2003-04. The current year is unlikely to witness the same level of by
the manufacturing sector.
The government intends to borrow Rs 45 billion for
budgetary support and another Rs 5 billion for commodity operations
during the on going financial year. Given that the government's bank
borrowing recently at over Rs 60 billion against a target of Rs 10.6
billion, the above mentioned value should not be taken at face value.
Additionally, the government aims to borrow Rs 84.8 billion through
auctions of Pakistan Investment Bonds, Rs 74.8 billion from the banking
sector and Rs 10 billion from the non-banking sector.
The Agriculture Credit Advisory Committee has
suggested a target of Rs 85 billion for 2004-05. This translates into a
30% growth over last year's target and 16% rise over actual disbursement
during 2003-04. Increased emphasis by the government on the agricultural
sector, reduced interest rates for farmers and the introduction of new
agri products by banks should help in achieving, if not exceeding, this
target. While the Zarai Taraqqiati Bank continues to be the single
largest lender to the farming sector, all major commercial banks have
significantly increased their participation in the agri sector. This is
likely to go a long way in increasing the disbursement of agriculture
The SBP has been gradually tightening the monetary
policy for some time. A slow, but steady rise in interest rates has thus
already been priced in the market. Consequently, analysts do not expect
this policy statement to have any significant impact on the stock market
because the market is focusing on growth rather than dividend yield.
Besides, the SBP conscious of maintaining the growth momentum, interest
rates are not expected to increase significantly.
Some of the brokerage houses have carried out
detailed analysis of impact of hike interest, both long-term and
short-term rates, on the KSE-100 Index. One of the studies shows that
the relation between 6-month rates and the KSE-100 is highly negative.
However, it is relevant to point out that this was primarily due to the
impact of lower financial costs leading to earnings growth over the last
few quarters. The story going forward is likely to be focused on top
line growth that is likely to be unhampered if the interest rate
increase is limited to 100-175bps from current levels.
According to some analysts, monetary expansion in
2004-05 is likely to exceed the target set by the credit plan. There are
three reasons for this assertion: 1)
While private sector credit should be less than that witnessed during
2003-04, the introduction of new products by banks could further
invigorate interest in consumer financing. Moreover, a rise in the
import cost of raw material goods due to higher production capacity is
likely to compensate for the decrease in capital expenditure by
manufacturers. The combination of these factors could result in
surpassing the private sector credit target. 2)
The target set for government borrowing is likely to be
surpassed during 2004-05 as well. 3)
The greater emphasis on the agri sector by both the government and the
commercial banks is likely to result in greater disbursement to the
sector than is envisaged by the plan.
Vigilance by the SBP to keep the exchange rate and inflation stable
will be positive for the economy. The policy statement elucidates SBP
stance that it will not allow the interest rates to increase rapidly
as it may adversely impact the growth momentum of the economy. The
growth in 2004-05 is likely to reply significantly on external demand
driving the textile exports, and a gradually weakening exchange rate
will help export competitiveness. Any measured increase in the
interest rates is unlikely to have any significant negative impact on
the economic growth prospects.