S.KAMAL HAYDER KAZMI,
Research Analyst, PAGE
Feb 20 - 26, 2012
MONETARY AGGREGATES (% GROWTH)
. FY 10 FY11 Broad Money (M2) 12.5 15.9 Of which Government borrowing 20 23.7 For budgetary support 19.7 29.3
In spite of active monetary management, FY11 turned out to be yet another year with double-digit inflation, fueled by supply side factors including devastating floods at the beginning of the year, and strong global prices of oil and agriculture commodities.
On the demand side, massive government borrowing from SBP especially during first quarter of the year added to inflationary expectations. After November 2010, the government switched its borrowing from SBP to the commercial banks. While this is a welcome development for managing inflationary expectations, it does crowd out the private sector. The supply constraints not only kept inflation high, but also hurt growth. Economic activities were increasingly disrupted by persisting electricity and gas shortages, heightened security concerns, and increased cost of capital. Both inflation and real GDP growth targets were not met. Actual annual inflation turned out to be well above the targeted level in FY11 as has been the case since FY06, and real GDP growth remained below the target for five out of the last seven years. Formulating monetary policy in this environment is especially demanding since policy measures to contain inflationary pressures entail the risk of further restricting economic activities. Being mindful of these challenges, SBP has vigilantly made use of any possible room available to contain inflation and support economic activities in recent years.
In addition to adjusting the policy rate, SBP has also been implementing measures to improve its monetary policy framework and support business activities.
MONETARY POLICY STANCE IN H1FY11
SBP's inflation projection at the beginning of FY11 was in the range of 11 to 12 per cent for the year, compared to the government target of 9.5 per cent. Inflationary pressures were on the higher side since there was no easing in government borrowing from SBP. The government net budgetary borrowing from SBP reached Rs65.0 billion in first three week of July 2010, in addition to an increase of over Rs100 billion during the second half of the previous year. Containing the fiscal deficit for FY11 at the targeted level of four per cent was clearly going to be very difficult. The possible impact of implementing a reformed GST, as agreed with the IMF, and upward revision in electricity tariffs worsened the inflationary outlook.
The floods undermined government efforts to contain fiscal deficit. Expenditures of federal and provincial governments significantly increased, priorities were shifted from development expenditures towards rehabilitation of flood affectees, and the efforts to collect revenues suffered a major setback.
The widening fiscal deficit was largely financed through short-term borrowing from the banking system. Specifically, government borrowing from SBP rose to Rs220.3 billion during September 2010 from the beginning of the year. Reserve money also registered an expansion of 9.4 per cent over the same period compared to 11.4 per cent for the full year of FY10.
BORROWINGS FOR BUDGETARY SUPPORT
Budgetary borrowings from the banking system reached a record high of Rs590.2 billion during FY11 compared to Rs330.4 billion in the previous year. In addition to this, the government also borrowed Rs424 billion from other domestic sources of funding. Fiscal slippages and shortfall in external financing left the government with no option but to rely on domestic resources. However, an important development during FY11 was the welcome shift in the composition of budgetary borrowing from the SBP to scheduled banks. Specifically, the government retired Rs8 billion to the central bank during FY11. It may be pertinent to note here that during Jul-Nov FY11, the burden of deficit financing remained concentrated on the SBP. During FY11, government borrowing from scheduled banks increased since there was no recipe for curtailing the overall size of the fiscal deficit. Scheduled banks were able to finance budgetary requirements of Rs598.2 billion during FY11.
MACROECONOMIC INDICATORS FY11 (AS % OF GDP)
INDICATORS TARGETS ACTUAL Net investment 15.4 13.4 National savings 13.2 13.6 Total revenue 15.2 12.5 Tax revenue 11.0 9.4 Current expenditure 14.8 16.1
A sharp reduction in external financing of the fiscal deficit in FY11 exerted significant pressure on domestic sources of funding. Data show that only nine per cent of fiscal deficit in FY11 was financed through external borrowing. In absolute terms, the government borrowed Rs1.4 trillion from the domestic sources in FY11. As a result, the stock of domestic debt reached Rs6 trillion, indicating year on year (YoY) increase of 29.3 per cent during the year. This expansion in government borrowing is not only a drag on private economic activities, but also has strong implications for the use of fiscal policy as a macroeconomic stabilization tool. Further, interest payments on domestic debt rose to Rs649.9 billion in FY11 compared to Rs577.7 billion in the previous year. This increase was largely due to the sharp increase in short term government borrowing during FY11 discussed earlier, and a re-pricing of the accumulated stock of floating debt as of end FY10.
The entire of stock of Rs2.4 trillion at the beginning of the year was rolled over during FY11 on higher interest rates, as the SBP policy rate rose by150 bps during H1-FY11. Specifically, the interest on floating debt jumped to Rs361.4 billion; this represents YoY growth of 49.9 per cent. Interest payments on permanent debt also grew by 23.6 per cent in FY11, on account of both volume and price effects.