ECONOMIC IMPACT OF CUT TO BE MARGINAL
SHABBIR H. KAZMI
Oct 17 - 23, 2011
The State Bank of Pakistan (SBP) surprised the analysts by announcing a 150bps cut in the policy discount rate to 12 per cent. The general expectation was that the reduction would be minimum 50bps and maximum 100bps.
The more than expected cut has been attributed to: 1) expected average CPI inflation of 12 per cent in FY12, in line with the government's target owing to the change of CPI base and methodology, 2) containment of government borrowing from SBP and 3) a comfortable external account, albeit one that requires vigilance.
While analysts expect some improvement in private sector credit off-take, the government is likely to be the biggest beneficiary considering inflated domestic debt servicing was adding to pressure on an already bloated fiscal deficit.
Going forward, the country continues to face macroeconomic risks in the medium term with repayment to International Monetary Fund (IMF) commencing from February next year.
Keeping in view eroding foreign exchange reserves, exchange rate is expected to come under pressure particularly if domestic price pressures pick pace again.
With September CPI clocking in at 10.46 per cent (average 1QFY12 CPI of 11.48 per cent) and expectations of a further dip in price pressure in the near-term, the SBP has reduced the discount rate. This quantum of rate cut was last seen in late CY02 when the policy rate was cut from nine to 7.5 per cent.
The situation in the forthcoming days is not likely to be as comfortable as being portrayed by some of the quarters. However, even with rebasing, any increase in inflation will result in CPI exceeding 13 per cent by February next year which can completely stall the easing process.
Added to this is the pace of sequential price increases in the aftermath of floods, hike in electricity and gas tariffs and above all electricity outages still hovering around 10 hours a day. The situation is likely to further deteriorate with the commencement of winter in the northern areas. With the decline in water level in dams, the reliance on thermal power plants will result in quantum increase in furnace oil import. Similarly, industries, particularly fertilizer plants and textile processing units will face curtailment of gas supply.
Any reduction in output of textiles and clothing will not bode well for exports as cotton and the sector contributes nearly 65 per cent to the overall exports. Depletion of foreign exchange reserves will lead to erosion in rupee value against dollar and all other leading currencies and also add to the burden foreign debt servicing.
Those who believe that this substantial reduction in interest rate will usher in fresh investment are totally disoriented. Entrepreneurs add new capacities when the existing capacities are fully utilized. The harsh reality is that the average capacity utilization of industrial units hovers around 50 per cent at present because of electricity and gas outages. It has been stated repeatedly that the energy crisis is an outcome of brutal assassination of good governance and running of power plants far below the capacity. This can be gauged from the fact that at present electricity generation ranges from 12,000MW to 16,000MW (including KESC) as against an installed capacity of 24,000MW.
Lately, combined output of two of the biggest IPPs (Hubco and Kapco) declined to 700MW against an installed capacity of 3,000MW. This was only because of highly inadequate supply of furnace oil.
It was believed that 150bps reduction in discount rate would create massive rally in the stock market. On the expectation of reduction in interest rate, the benchmark index witnessed some substantial gains but slowly the euphoria is dying due to no expectation of resolution of energy crisis. Energy related stocks enjoy heavy weightage in the index and most of the companies belonging to the energy chain are the victim of circular debt.
Profitability of gas marketing companies will remain under pressure because of huge receivables which on one hand increase their financial cost and do not allow them to add to their operating assets, particularly expansion and revamping of the transmission and distribution networks on the other.
Similarly, cash starved exploration and production companies have not been able to accelerate drilling activities. Actual drilling has been far below the target in the recent past. Failure in accelerating drilling activities dampens chances of new discoveries and drilling of fewer production wells does not allow in increasing indigenous production of oil and gas.
However, some of the analysts insist that E&P companies do not suffer from cash crunch but 'over milking of the cows'. In fact, over the years the government, which has the largest stake in these companies, has been draining out most of the cash by declaring fabulous dividend year after year. This lust is evident from the fact that often the government forces the boards of these companies to approve payment of interim dividend before completion of the quarter/year.
This has been most common in case of Pakistan Petroleum. OGDC's exploration and production activities are also impaired due to the payment of massive dividend.
One of the factors contributing to budget deficit is the black hole of state owned enterprises (SoEs) that sucks in around Rs300 billion annually. The losses incurred by these entities are only due to gross inefficiencies and mismanagement.
Similarly, failure of the Federal Board of Revenue (FBR) to broaden the tax net has pegged revenue collection. Provinces have also been failing in collecting tax on income from agriculture. During last financial year income of farmers increased substantially due to higher commodity prices but tax from agriculture income has not shown corresponding increase.
Poor tax collection and extravaganzas of the government lead to massive borrowing from the central bank as well as commercial banks. This leaves little for the private sector. However, there is an urgent need to bring a change in the mindset of bankers who prefer to lend more to the government and abstain from extending credit to the private sector.
There is a lot of talk about achieving food security but lending to farmers has not been increased. Bankers say that lending to farmers is riskier but fail to provide a plausible reason for not insuring the credit extended to the farmers. In fact, by this time they should have come up with a comprehensive crop insurance scheme to boost lending to the farmers.