IS MONETARY TIGHTENING JUSTIFIED IN PAKISTAN?

SYED FAZL-E-HAIDER
Nov 23 - 29, 2009

The central bank in September kept its policy rate unchanged at 13 per cent for October and November amid fear of fiscal slippages and concern that inflation may not have peaked. The falling inflation has given hope that cost of doing business will be reduced with the possible reduction in the interest rates by the central bank. There is a dire need to make further cut in the interest rate to turn the economy around and enhance industrial productivity, which is at its lowest due to multiple reasons including acute energy shortage.

Critics say that monetary tightening is not justified in a country where consumer financing has not been more than five percent. Despite high interest rate, the core-inflation remained at a higher side clearly indicating that this policy did not yield the required results.

Consumer price index (CPI) rose 8.87 per cent in October, the slowest pace in 22 months, according to the Federal Bureau of Statistics (FBS). Inflation peaked at a record high of 25.3 per cent in August 2008 because of higher commodity and oil prices before easing in 2009.

Under the new monetary policy, Pakistan's central bank for the second time this year cut on August 15 its discount rate, its key policy rate, by 100 basis points to 13 per cent. A fall in annual inflation to 11.2 percent in July from 19.1 percent in March provided the central bank a passage for the cut in the policy rate to give breathing space to the country's ailing economy. The bank had cut the interest rate by 100 basis points to 14 percent in April after increasing it by 500 basis points last year to curb inflation that reached a 30-year high.

Critics say that the government's current monetary policy is not an expansionary policy in its contents but it is the continuation of the concretionary monetary policies adopted by the central bank for the last three years. Local businessmen still consider interest rates very high and 300bps cut in the discount rate a must, which can help the ailing economy. Experts say that significant reduction in discount rate bringing interest rate down to single digit is essential to rescue the ailing industry.

Pakistan is the only country in the region where interest rate is still higher. The country lags behind its neighbors in economic growth and exports due to high interest rate and energy crisis. The other countries have already reduced the interest rate to the lowest level. As compared to13 percent interest rate in Pakistan, the neighboring India is currently managing 3 percent. Critics say that while other countries of the world are cutting down their discount rates to boost the economic growth, Pakistan has raised policy discount rates despite the negative growth in the industrial production.

Reduction in discount rate by at least 300 basis points is essential to provide relief to the ailing industry and trade.

In its recently issued annual report for 2008-09, the country's central bank said the fiscal and current account deficits were likely to be 4.7 per cent and 5.2 per cent against previous year's 5.2 per cent and 5.3 per cent, respectively. The economy was hit by deterioration in the security and law and order situation and lower demand for major consumer durable goods because growth in real incomes weakened and credit contracted.

For the second consecutive year, the target of 2.5 percentage point reduction in foreign debt and liabilities, as per cent of GDP, has not been met, according to the country's central bank. The country's total debt and liabilities (TDL) stock recorded a 27 per cent increase in last fiscal year 2008-09 against previous year's 27.4 per cent.

Critics say that the rising debt would leave nothing for the private sector and contraction in credit for private sector would lead to further slump in business activities. Instead of resorting to foreign borrowing, the government should take measures to reduce non-development expenses and widen tax base by bringing more sectors in tax net to generate more revenues.

The textile industry, which accounts for two-thirds of our exports, is still struggling to revive growth amid rising interest rates. Pakistani exporters may fail in fulfilling the European and American apparel export orders worth $1billion for Christmas due to high price of cotton and yarn in the local market. The cost of doing business is constantly without giving any sigh of relief to industrialists.

The exports of apparel from Pakistan in the last ten years had increased from $1.5 billion to only $3.5 billion, whereas in Bangladesh the exports increased from $1.5 billion to $12.5 billion, which showed that Pakistan's exports were much below as compared to other competitors in the region.

The country exports textile products worth $3 billion a year to the US where the total textile market is worth as much as $110 billion. The country's share in the American market could grow to $10 billion in a short time if Washington agrees to allow it duty-free market access. Local exporters say increase in their share of the American as well as the European markets is hampered by duty-free access given to textile exports from Bangladesh and Sri Lanka.

Pakistan's frontline role in US-led global war on terror has not been without social, economic and human costs. Local business community called upon the US Secretary of State Hillary Clinton to give practical shape to her announcements made during her recent three-day visit to Pakistan last month for providing direct access to Pakistani products in US markets. Last month, the visiting Hillary Clinton in her interaction with local businessmen in Lahore promised that the US government would work on all options, including signing a free trade agreement with Pakistan and setting up of Reconstruction Opportunity Zones (ROZs) in the tribal areas, and allowing greater access to Pakistani textiles.

She however did not commit to meet the country's demand for greater access to its textile products to the American market.

The government claims that it has achieved all IMF targets, but what about the targets set by the government for the current budget. Analysts predict that the country is heading toward another financial crisis in the year 2010-11 due to the government's dependence on IMF's loans. Local industry is facing power shortages and squeezing local and international demand, while banks are not risking their money to support the private sector.