TIME TO TIGHTEN
Credit to private sector registers robust 22.3pc growth despite increasing interest rates
Dec 04 - Dec 10, 2006
Governor State Bank of Pakistan (SBP) Dr. Shamshad Akhtar looks confident and happy over what she called stellar growth achieved by the banking sector, saying that it is the responsibility of the central bank to facilitate and guide the financial sector move in the right direction.
While releasing the SBP's Annual Report 2005-06, Dr. Shamshad Akhtar said though she believes the solution for balancing the spread lies in healthy competition among the market players, however, the central bank might use its powers against the banks not complying with the laid down principles.
When her attention was drawn towards the multiplying interest based incomes of the banking sector and their reluctance to pass it on to the depositors, Dr. Shamshad was of the view that earning profits is not a sin rather it indicates healthy signs in the country's financial sector. She, however, agreed that the benefits of growth should have a trickle down effect to all the stakeholders, including depositors. She suggested that the people in order to have a share from the growing economy should deposit their money in term financing instead of going for saving or current account deposits.
Commenting on what it is being called influx of foreign investment in the banking sector, she was of the view that it was actually a matter of pride that international leaders of global standing are coming to Pakistan which are not only bringing investment and meeting the rules of the State Bank but they are instrumental in attracting more foreign investment in various areas as well.
"These foreign investors in the banking sector would introduce innovative financial mechanism, which is desirable to elevate our system," she added.
Referring to the acquisition of Union Bank by Standard Chartered, she said that the Standard Chartered has an ample experience in promoting SMEs and they have assured to play a positive role in promoting SMEs in Pakistan as well. She expressed her confidence that the foreign banks having a much bigger reach in global prospects would lend a strong supporting hand for the economic growth in Pakistan. They would be supporting in facilitating overseas Pakistan in their remittances from anywhere in the world.
Coming back to interest rates, the SBP Governor said that people usually talk about nominal interest rates instead of looking at the real interest which is minus CPI rates and comes only to 2.5 percent in Pakistan. The total investment to GDP ratio rose to 20.0 percent during financial year 2006 from 18.1 percent in the preceding year and an average of 17.1 percent in the last five years. Importantly, this is the highest level of investment to GDP ratio in over a decade.
INC: Including, EXC: Excluding
The rise in the ratio is mainly attributed to improved confidence of local as well as foreign investors on the back of a good showing of the economy and a robust 22.3 percent growth in credit to private sector despite increasing interest rates, the governor observed.
The national savings rose sharply by 16.7 percent during financial year 2006 as compared to the 7.5 percent growth in the preceding year, nonetheless this increase in lower than the rise in nominal GDP. As a result, the national savings to GDP ratio dropped slightly by 0.1 percentage points to 16.4 percent during 2006, the lowest level since financial year 2001.
Dr. Shamshad Akhtar said that the reason why despite rising interest rates, national savings to GDP ratio did not improve could be the prevailing negative real returns on deposits being offered by the banks. Other factors, she pointed, out were including the rise in National Savings Schemes (NSS), reluctance in issuing PIBs and continued consumption boom in the economy.
Both public and private investment contributed in the rise of total investment during financial year 2006, however, increase in the latter was more pronounced. It is important to note that a significant rise in public investment in infrastructure during past three years resulted in a trend reversal in private investment as well.
Foreign direct investment in the economy more than doubled for financial year 2006, reaching as a high as $3.5 billion, which suggests the improved macroeconomic fundamentals and relative policy stability of the economy is attracting investors' interest. Although half of this FDI represented to privatization proceeds on account of PTCL privatization, sale of shares of KESC and receipts on account of HBL, but even adjusting for these FDI has registered a rise of 70.6 percent.
Some analysis suggests that these flows are mainly concentrated in the telecommunication, power, finance and insurance and oil and gas exploration sectors.
In terms of geographical origin of FDI, a significant shift in favor of Middle East is evident in recent years and resultantly the share of North American countries (mainly USA), Europe (mainly UK) and East Asia Pacific (mainly Japan) has shrunk considerably since financial 2003, she observed.
Pakistan's economy witnessed a strong performance for yet another year in financial year 2006, with real GDP growth of 6.6 percent remaining higher than the desired long-term average of 6 percent. This was supported by strong growth in exports and private investment and probably contributed to a further reduction in poverty. The sustained high growth is quite creditable given the many adverse developments, such as very sharp increase in oil prices, and the October 2005 earthquake.
For the first time in six years, the expansion in broad money (M2) was lower than the nominal growth of the economy; i.e. the pace of money creation was lower than the generation of goods and services in the economy. The monetary tightening coupled with administrative actions by the government to lower food inflation helped contain average CPI inflation within 8 percent annual target, without prejudice to the country's long term growth momentum.
She pointed out that there are, however, some areas of concern such as a relatively narrow growth base and persisting high inflation. The pressures in fiscal deficit in the backdrop of a nearly stagnant tax base have kept the tax/GDP ratio in the 10 to 11 percent range for over a decade, and the widening of the current account deficit.
The policy environment for financial year 2007 is even more challenging as monetary policy is required to support both a lower inflation target of 6.6 percent in 2007 as well as a higher real GDP growth.
The State Bank of Pakistan's projections suggest that real GDP growth is likely to be close to the 7 percent annual target in financial year 2007, helped by a recovery in agriculture and industry as well as yet another robust performance by the service sector.
The expansionary fiscal policy in 2007 has compounded the risks to the economy. Besides adding to inflationary pressures, the government's higher funding requirement induces more pressures to raise interest rates to curb international pressures on the economy. The key fiscal risk may emerge if the necessary growth in expenditures is not matched by a commensurate increase in revenues, resulting in the loss of the hard-won fiscal space gained in recent years.
Other than improving the tax base in order to sustain robust development spending as well as contain growth in the fiscal deficit, the government needs to diversify its sources of borrowings, adopt a judicious mix of short-term and long-term borrowings and ensure that the sanctity of the overall yield curve (which has evolved as a result of effective market price determination of debut) is maintained. Greater focus and reliance on different maturity and, in particular, long term PIB issues would be desirable rather than once again offering NSS instruments on-tap to institutional investors. As a matter of fact, effective debut management and its pricing are critical to facilitate the development of a long-term corporate debt market — an area where progress has been stalled.
The widening external imbalance has been another concern. Pakistan has so far been able to finance current account deficit smoothly because Pakistan's overall strong economic performance and reforms have enhanced investor confidence, helping country access the international debt market on relatively favorable terms. However, this cannot be continued over the medium term without incurring high costs, including a rise in the cost of accessing international capital markets, lower investment flows and greater vulnerability to external shocks.
Strong fiscal stimulus and widening current account deficit together with the risk of an above-target inflation outcome serves to highlight the need for a continuation of a tight monetary posture in financial year 2007. In doing so, the central bank would be mindful of inherent danger of excessive tightening, hurting growth momentum.