Feb 28 - Mar 6, 20


TIPPU SULTAN: I am currently working as Head of Advisory Services Unit, at the W.T.O. Cell at the Trade Development Authority of Pakistan, for last three years. I did my C.S.S. in 1985, and joined the commerce & trade group. As part of the civil services, I have worked at the National Tariff Commission, Islamabad, the Ministry of Commerce, and the former Export Promotion Bureau. My academic career comprises of a B.S. in electrical engineering from USA. Subsequently, when I joined civil service, I took up studies in economics, and completed an M.A.S. from Applied Economics Research Centre, University of Karachi. However, not finding the services structure, both pays and promotions, to my liking I resigned from service in year 2000, and went into business, where I was one of the pioneers of CNG refueling in the country. My company was the first to convince PSO and Shell, to add CNG refueling at their existing service stations, which was unheard of only a little while ago. Living in Canada in year 2004-5, my interest in academics resurfaced, and I did an M.A. in political economy from Carleton University, Ottawa. I have written a few articles on the subject of political economy in the Pakistani English newspapers and also appeared on TV channels in shows concerning Pakistan's trade, commerce, and economy in general.

When asked about his opinion about monetary policy in Pakistan and what kinds of efforts are required for lower interest rates in Pakistan as well as where he sees interest rates going in the days to come in Pakistan, Tippu Sultan said, 'I would like to answer all of these questions in one composite response. In that way, you would better appreciate that these sub-questions are all answered while analyzing the recent monetary policies Pakistan has followed.' Monetary policy is about decisions regarding amounts of money supply and prevailing interest rates in the country. Thus, it is concerned with money creation, level of optimal interest rate, and level of inflation in the economy. However, all three are interdependent, and change in one makes change in the other two inevitable. Hence, to understand the workings of the monetary policy in Pakistan, a general overview of these economic indicators, in the last three years, would provide a clearer understanding of the whole picture. Fighting inflation has been the focus of our monetary policymakers, which has been persistently high for almost last three years now. Some experts however are of the view that high inflation in Pakistan is a 'supply side' phenomenon, and there is no role for the monetary policy to contain inflation in our country. Others cite fiscal weakness and large budgetary deficits as the main reason behind high inflation, leaving little room for monetary policy tools to fight inflation. Fiscal authorities, with an eye on re-elections, are always in the big spending mode, which causes high budgetary deficits, which then leads on to inflationary pressures. Monetary authorities, on the other hand have a harsher stance on deficits and inflation.

Looking deeper into the high inflation phenomenon in Pakistan, we note that the food prices have grown by nearly 100 per cent in the last three years. Credit extended by the government, for commodity operations, including wheat and sugar, grew by nearly 300 per cent in the last three years. This level of borrowing by the government causes pressure on market interest rates. The borrowings of government agencies for financing its wheat, urea, and sugar operations have been around Rs382 billion at just under three percentage points above KIBOR, which results in obvious upward pressure on interest rates for private sector borrowers. These large amounts have thus been injected into the rural areas, which was then used for higher expenditure on consumer durables and other food items as well. Thus an initial 'supply shock' (of raising wheat procurement prices, for example) turned into 'demand shock', and adversely affected the expectations of inflation remaining high. Even excluding food and energy prices from the Consumer Price Index (CPI), we see substantial increase in inflationary pressures. Thus, both non-food, non-energy (NFNE) measure of core inflation saw increases, as NFNE grew by 58 per cent in the last three years, as compared to 28 per cent in three years before that. Primary fiscal deficits grew by 3182 per cent (in nominal terms), as compared to an improvement of 140 per cent in three years before that.

Similarly, revenue deficit increased by 298 per cent compared to 27 per cent, for three years before that. Cumulative government borrowing from the banking system, in the last three years increased by 187 per cent compared to 58 per cent three years before that. Within the banking system, reliance of the government on the State Bank of Pakistan is very high: the stock of outstanding borrowings of the government from the SBP is over Rs1500 billion today, as compared to only Rs53 billion at the end of June 2003. Had the government borrowed this kind of amount from scheduled banks, effect on the interest rates would have been tremendous, and the interest rates would have been much higher.

Borrowing of this scale would not be possible without a corresponding increase in interest rates. The government has considerably crowded out the private sector both through reduced credit availability, and high price of credit (i.e. high interest rates). Thus, private sector credit grew by 162 per cent between June 2003 and June 2007, while it grew only by 24% per cent between June 2007 and November 2010. Another downside of heavy government borrowing was the deterioration of the currency-to-deposit ratio of the banking system. While in the period June 2003- June 2007, currency circulation went up by 70 per cent, and total deposits of banking system (excluding government deposits) went up by 104 per cent, during the period June 2007- Nov 2010, the currency circulation went up by 82 per cent, but the deposits went up only by 40 per cent.

While currency in circulation has a high correlation with overall inflation, decline in deposits has a contractionary effect on market liquidity and causes upward pressure on market interest rates. As to how did the economy cope with the aggregate demand pressures in the period 2003-2007, it is seen that the contributions of government and private sector were somewhat 'balanced', despite aggregate demand pressures relative to available productive capacity. Thus, cumulative growth in trade deficit was 2605 per cent for the period.


TIPPU SULTAN: It was because the economy was largely able to finance this demand from capital inflows from abroad: a cumulative 1462 per cent increase in foreign investments and 83 per cent increase in Net Foreign Assets (NFAs) of the banking system. In the period June 2007-Nov 2010, the situation is quite different. Despite the tight monetary policy of the SBP, decline in international commodity prices, and the trade deficit growing only by 18 per cent, both foreign investments and net foreign assets, decreased by 74 per cent and 37 per cent respectively. Had SBP not responded, the inflation outlook and reserve position would have been much worse e.g. growth in Broad Money (M2), and thus inflation would have been much higher if private sector had also continued to borrow unchecked from the banking sector, along with the public sector. In view of these varied pressures on the economy, it is expected that tight monetary policy would be continued in the short to medium term. That would keep the inflation in check, but would result in keeping interest rates high. While the government needs to revisit its commodity intervention strategy, and work on complete resolution of the circular debt, an upward revision in the SBP's policy rate, at this juncture, runs the risk of impeding the still nascent recovery, while a downward adjustment (reducing interest rate) runs the risk of fuelling an already high inflation. Hence, the State Bank, which is in charge of the monetary policy, is holding the policy rate unchanged at 14 percent.