FLIP SIDE OF TIGHT MONETARY POLICY

HAMADULLAH ABRO
RESEARCH ANALYST
Feb 25 - Mar 02, 2008

Monetary Policy 2H-08 announced by SBP is more focused to contain inflationary pressures and rectify imbalances in the economy. She ignored the negative impacts on different sectors which can hamper economic growth.

Pakistan's economy has been witnessing unprecedented growth of 7% (on average) for last 5 years. It is possible due to effective use of monetary and fiscal policies along with Administrative measures, economic and banking sector reforms, political stability which helped Pakistani economy to move on growth trajectory for last 5 years. As a result, agriculture, manufacturing, services sector, foreign reserves, Investment and remittances grew at an impressive rate.

Pakistan has been pursuing expansionary fiscal and monetary policies to create consumption led growth in an economy, which have undergone to considerable changes since 2002 in response to changing dynamics of domestic and global economic environment. SBP tightened monetary stances since 2005 to keep price and growth stable. SBP has raised key policy rate by 150bp to 10.5% in 2H-FY08 from 9% since 2H-FY06 along with other monetary policy tools to contain inflationary pressures. Monetary policy has not achieved any concrete results yet. Inflation keeps on rising projected in the range of 8% for FY07-08 because of highest ever Government borrowing and hiking food inflation, diluting the impact of monetary policy.

This is one side of the coin; flip side is of grave concern. Tight monetary stances have affected negatively almost all major sectors of an economy namely textile, financial, corporate, consumer and industry, which have potential to hamper GDP growth in coming years because growth was steered with credit flow.

PRIVATE SECTOR BORROWING

Private sector borrowing has been decreasing since last year. The slowdown in the private sector credit flow is likely to impact on industrial growth. In the last fiscal year, growth in the large-scale manufacturing had declined to 8.5% against the targeted 12.7%, investment declined to 21.37% as against 32.27% last year, partly because higher interest rates had lowered private sector's borrowing from bank. It is expected the industrial sector growth falls short of target; it means we won't achieve the economic growth target in current fiscal year. Main reasons are high cost interest rates which cause them investing in less risky investments, low interest rate differential between private and public lending and escalating government borrowing to fill fiscal gap which gave rise to crowding out effect. [See Table 1 & 2]

TEXTILE SECTOR

Textile is backbone of our country contributing 9% in GDP, 46 % of total manufacturing and 60% to our exports. But now, textile export factories are closing down due to energy crisis, low outputs and further tightening of monetary policy has increased the cost of borrowing which is evident from 40 per cent less import of textile machinery during current fiscal year.

INDUSTRIAL AND CORPORATE SECTOR

Business and corporate communities detested further tightening monetary stances and termed it as one of the main reasons of slow growth in industrial sector, manufacturing which grew at 8.45% in FY07 as against 10% in FY06 and decline in investment which grew at 21.31% in FY07 as against 31.27% in FY06, all these factors will affect adversely economic growth in long run. Increase in interest rates has increase their cost of doing business along with other factors like energy crisis, political instability consequently profitability will decrease. [See Table 2]

BANKING SECTOR

High interest rate will certainly affect their advances growth and increase in bad debts which will affect the profitability of banking sector in FY08. This is evident from Advance to deposit ratio which has been declining due to slow growth in private sector borrowing, on other hand increasing domestic deposits and due to high interest rates foreign inflows are coming into banking sector. ADR in 2007 has declined to 70% from 80% in 2006. On other hand investments to deposit ratio was 38.6% in 2007 against 26% in 2006 [See Table 3]

CONSUMER SECTOR

Consumer loans which is one of the main factors of growth in real estate, auto sector, retail etc have been showing declining trend due to higher interest rates. Declining trend will definitely affect the performance of these in near future. Consumer financing which grew at 5.95% during Jun-Dec 07, slower than 9.82% June-Dec 06. [See Table 1]

AGRICULTURAL SECTOR

Pakistan is an agricultural country with 2/3 of the population depends on the sector. During last 5 years growth in agriculture was dismal except in FY04-05 and FY06-07 in which it grew at 6.5% and 5% respectively, due to Government negligence. Textile, which is one of the major sectors of an economy, is dependent upon performance of agriculture sector. Textile sector has been under performing for last few years due to bad performance of agriculture sector because of government negligence, low access to credit.

In order to give relief and boost to this sector SBP has increased allocated farm credit to Rs 200bn from Rs 15bn. It is expected that agriculture credit will grow in FY08. [See Table 1 & 2]

OUTCOME

As I mentioned earlier tightening of monetary policy has not drawn yet any fruitful results because of hiking good inflation, soaring oil prices and escalating government borrowing. Government should consider the alternative sources of energy to decrease dependency on imported oil and take administrative measures to resolve supply side issues to contain food inflation. Both (inflation and interest rates) are, despite going to opposite direction, moving in same direction and affected GDP growth, which is expected to decline in FY07-08

FUTURE OUTLOOK

It can be projected that further tightening of monetary policy may not bring desired results because, despite tight monetary stance since mid-2005, neither the inflation could be controlled nor money expansion (which has grown to 19.3% in FY06-07 against target of 13.7%) could be properly managed for last 3 years. On other hand, fiscal account deficit is expected to grow to 5.5% of GDP in current fiscal year, indicating that the government will finance the gap by borrowing more from commercial banks and central bank. It is worth mentioning here that, they have already financed almost 60 per cent of budget deficit from July 07 to January 29, 08. It can be inferred that private sector growth will decline in years to come along with elevating energy crisis, soaring international oil prices, which will result in slow economic growth.

TABLE 1 (AMT IN RS MLN)

DESCRIPTION

JUNE 06

DEC-06

GROWTH
%

JUN-07

DEC-07

GROWTH
%

Private sector credit

1,957,418

2,198,650

12.32

2,294,800

2,562,819

11.68

Agriculture

134,401

144,889

7.80

147,090

158,741

7.92

Manufacturing

899,727

1,006,477

11.86

1,003,448

1,117,153

11.33

Textile

436,835

478,359

9.51

438,377

500,030

14.06

Personal loans

342,852

375,557

9.54

398,858

422,955

6.04

Bank Employees

45,076

48,531

7.67

50,425

53,779

6.65

Consumer Financing

297,776

327,026

9.82

348,433

369,176

5.95

For house building

43,205

48,937

13.27

54,672

63,623

16.37

For transport

97,777

105,329

7.72

105,444

113,035

7.20

Credit cards

33,538

39,198

16.88

42,822

46,844

9.39

Consumers durable

1,547

1,324

(14.39)

1,039

909

(12.54)

Personal loans

120,517

130,453

8.24

142,373

142,732

0.25

Other

1,192

1,785

49.72

2,082

2,034

(2.32)


TABLE 2 (GROWTH RATES %)

INDICATORS

2001-02

2002-03

2003-04

2004-05

2005-06

2006-07

2007-08
(JULY-DEC)

Inflation

3.54%

3.10%

4.50%

9.30%

8.00%

7.77%

8.01%

Money supply Growth (M2)

-

-

-

19.20%

15.07%

19.32%

6.09%

GDP Growth

3.60%

5.10%

6.40%

8.40%

6.60%

7.00%

-

Discount Rate

14%

7.50%

7.50%

9.00%

9.00%

9.50%

10.00%

Agriculture

0.10%

4.15%

2.43%

6.48%

1.58%

5%

-

Manufacturing

4.50%

6.90%

14.01%

15.51%

9.97%

8.45%

-

Commodity producing sector

1.37%

4.19%

9.29%

9.45%

3.42%

5.98%

-

Services

4.76%

5.22%

5.84%

6.59%

6.27%

8.45%

-

Investment

3.19%

10.66

14.45%

32.63%

32.27%

21.31%

-


TABLE 3 ( AMT IN RS MILLION)

PARTICULARS/ YEARS

2003

2004

2005

2006

2007 E

Advances

1169986

1589870

2043982

2409478

2497634

Deposits

1793176

2161098

2661697

2999895

3551182

Investments

745291

626046

730067

775546

1370688

ADR%

65.25

73.57

76.79

80.32

70.33

Investments to Deposit Ratio%

41.56

28.97

27.43

25.85

38.60