STATE BANK AND ITS MONETARY POLICIES

By SADAF AURANGZAIB
May 22 - May 28, 2006

The governor State Bank Dr Shamshad Akhtar has recently attended a lunch hosted by SITE Association of Karachi. This was her first visit to the SITE after taking up the responsibilities of State Bank governor. On her visit she listened to the views of the leading industrialists running various industries of the economic sector; she also brought about the issues concerning the monetary policies of State Bank of Pakistan.

The issues that were brought about by the SITE Association are inflation, rising mark up rates, export refinance rates, SME Financing, Looming trade deficit, weak industrial growth, tax base and cost of doing business.

The following issues have been answered by the Governor in its concise form to satisfy the growing apprehension of the industrialists. A brief summary of her speech is re-produced to give you a clear picture of the financing and trading sectors of the economy.

"I would like to touch upon some of the points that have been raised in the presentation to be more responsive to some of your concerns. I think first of all what I like to do is to talk about Macro Economics and with that context squarely talk about the trade deficit and second about the Export refinance scheme and there was also mentioning of the interest rates and the link to the KIBOR and so on the SME sector briefly so lets touch inflation which is a part of Macro economic environment. It has been pointed out, State Bank has issued its second quarterly report, it actually didn't unfortunately have the benefit of the data of the large scale manufacturing sector. So based on the data that we had State Bank Quarterly is projecting somewhere 6.3% to 6.8% of economic growth. We however hope to come up with fresh estimates in our third quarterly report."

Talking about the growth performance she pointed out that last year outstanding performance was driven among several things by very good performance of the agriculture sector and it is not unprecedented to see fluctuation in the economic growth. Second point is that growth above 6% is always a very strong economic growth so its only when we are in the range of 3% to 4 % there is a need to worry. She said that she is quite comfortable with the economic growth trend.

Expressing her views on the high trade deficit trend she said, "We State Bank in our reports has also expressed our concerns on the growing demand pressure as a result of high trade deficit. The fact has to be straightened here that the trade deficit for July to March period of fiscal year 2006 of which the data is available to us today indicates that the trade deficit as per State Bank Exchange record information is about 6.2 billion dollars relative to the Federal Bureau of Statistics numbers of over 8 billion dollars. There is a difference in the methodology of estimation of exports and imports between the State Bank and FBS and the difference in these numbers arises because we take data on the basis of exchange rate call and FBS uses the customs data. When we use the exchange record, we are talking about the actual cash transaction, realization of exports and actual imports that we have of which money have been paid. There is always a difference in the coverage also between us and the FBS and we are hoping that in months to come, we will narrow the differential between the FBS and State Bank numbers but clearly these are for right reason methodological difference which will remain there because we monitor the flow of money and they monitor the physical goods however State Bank has to have the final figures. So whether the trade deficit is currently 6 billion or 8 billion, it is actually high relative to last year. Now, is this something to worry about in the short term? The key explanation is that we as economic policy makers and assessors have to see that the way the trade deficit is being financed. The one it is fully financed and second the way it is financed is proper and I think for fiscal year 2006, it is important to record that there is availability of financing for this level of trade deficit and qualitatively we have managed to raise the adequate level of resources to finance this trade deficit. We have readily available resources to finance 2006 trade deficit. In this context we should take into account 4.2 billion to 4.5 billion of remittances, privatization proceeds, and sovereign bond issue. Now the situation as of today is at 6 billion trade deficit for which clearly we have adequate level of finances and in these financing I have taken remittances and other non-debt create inflows including privatization proceeds, foreign portfolio inflows, foreign direct investment and Sovereign bond proceeds. Subtracting from this financing the trade deficit we have foreign exchange reserves we have foreign exchange reserves of about 13 billion plus higher than 11.3 to 11.4 billion average reserves that we had for the first 8 to 9 months of this fiscal year so we are in a comfortable foreign exchange reserves position relative to what we were during the earlier part of the year.

However on higher trade deficit she said that the cause to worry is when trade deficit is beyond the means of financing because it does fuel one demand pressure, second because of growing demand pressures it produces regrettably higher pressure on the financing of the economy, and also produces pressures on inflation.

About raising the level of investment to build in economy she said that it is important for the medium term scenario.

About inflationary pressures and the monetary policies she said, the reason why we will be worrying about inflationary pressure is because while we do have financing available we do not have adequate level of industrial capacity in the country so what happening is while we are spending a lot of money and credit is flowing to different segments of the economy, the additions to the industrial capacity of the graph has yet to be realized and there you have an important role to play rather than us because the money has been given through the banking system to private sector. Today the private sector grows as a result of the central bank policies more than anything else. It has risen from 18 billion rupees in 2000 to 440 billion rupees for the fiscal year 2005, and the trend currently is that we are definitely in the range of 350 billion of private sectors credit at the moment. We have had a fairly easy monetary policy in this country for 4 to 5 years and it really in April 2005 when the inflationary pressure reached double digits 11.3 or 11.5 %, we had joined CPI in April and the Central Bank reversed instance from easy monetary policy to tightening the monetary policy. Now we have been twelve months in a tight monetary policy. The reason why I gave Central Bank the credit is that easy monetary policy of four to five years resulted in what you saw as 8.4% growth of 2005, I didn't say low interest rates were the reason for high economic growth, as economic growth comes from improved access to credit, the price of credit has in my view is to be determined by the inflationary pressures and it should always be determined in real terms and not in nominal terms. Pakistan Media and Pakistan Industry needs to cost always the price of credit and price of everything in real terms and we should start learning this discipline because rest of the world is always looking at the real GDP growth, real prices, real cost of credit and real discount rates.

While giving her views on interest rate trend she said that today the inflation so 6.1 but it misses 12 months average in this headline information and it may close to 8% so even if you take 8% , the real interest rate is positive by 1% having discount rate of 9%.

Talking about future inflation scenario and its handling she said that the future inflation scenario would be reasonable if we were to have the right economic policies and if the trade deficit pressure ease somewhat in two to three years time. However if the trade deficit grows at the same level as it is growing then that would be a cause for concern and there are about three ways of handling this situation. One is if you have to finance the trade deficit, you have to raise your exports which is the most non inflationary way of financing the trade deficit because trade deficit is actually your import growth, the second way to handle the situation is to lower your imports which is only possible in directed regime and is not possible today, the other non-inflationary way of financing is clearly the remittances and non-debt inflow if we attract more and more those than debt flows.

While commenting on devaluation as another way of handling trade deficit she said that in number of countries devaluation is one other alternate policy to make our exports more competitive so what can government do possibly on is of course as Central Bank we have to manage the monetary policy in an effective way and we believe that if the inflationary pressures were high we would have to be in a tight monetary policy regime and tight monetary policy regime translates into raising the discount rate to a level where it can curb the demand pressure. She also said that there is empirical evidence of testing the relationship between the devaluation and exports seem to indicate that in Pakistan depreciation of currency does not necessarily translate into export growth. On the contrary devaluation adds to other costs like it will raise the cost of your imports, raise the cost of debt repayment and so on so forth so it does result in other complications. What is important is that we have a free flow of exchange rate in Pakistan which is actually capturing the dynamics of the exchange use in the economy and where there are shortages in the system it is natural that the price of currency would be different from a situation where the depressions are easing. In past few weeks State Bank has tried to allow the exchange rate to have a free flow and Pak rupee did go down to 60.20 maximum moving from 59.85 that's the range exchange range is prevailing. As you may all have noticed that dollar is depreciated and is weakening, so clearly with the Pakistanis largely trade in dollar terms, obviously this weakening of dollar would enhance the competitiveness of the Pakistan exports. We need to understand the dynamic of this situation and the prevailing trend. The policy instance of State Bank will change in the line with economic dynamics of the situation.

She said that she is just explaining the conception that inflationary pressures if committed then the policy response would be this kind or that kind like Central Bank can manage the liquidity pressure to curb the demand pressure by raising the policy interest rates.

While defining the role which exports play in the economy she said that we have to stimulate the exports, financing is one part of stimulating exports, there are other things that need to do and we have already identified that utility access to raw material, access to capital growth with the imports growing at the rate at which it is growing I believe that industrialists are adding industrial capacity as the data on the breakdown of imports is showing that you are actually importing the right material and capital goods for adding the industrial capacity. It will be good to get that comfort that you are expanding industry through these imports and you are undertaking investment from the credit that is being supplied to you from the banking sector.

While talking about Export Re-finance Scheme, she said that fifteen years back when she was working as the Economist at the World Bank office in Islamabad, there was high misuse of export refinance scheme. Export refinance scheme is in operation since 1970's or so and it does provide a major source to the short term credit to the exporters to meet their working capital requirement. This scheme works in two parts, one is transaction based, the other is performance based and 70% of export refinance scheme is performance based. In terms of outstanding credit of refinance scheme, it is 60% of textile products, 11% for edible goods and 5 to 8 % leather. There are two schemes that were introduced through export refinance scheme, but both of them were not used by the SITE industrialists, and the banks are showing that literally nothing has been used through these schemes.

Lastly she also addressed the various concerns that were expressed in the forms of question and answer session after her formal presentation.