IMF ON MONETARY POLICY

SYED FAZL-E-HAIDER
(feedback@pgeconomist.com)

Feb 20 - 26, 20
12

International Monetary Fund's (IMF) report on Pakistan- that exposed the country' economic vulnerabilities and rejected the government's optimistic projections- moved the government to change the finance secretary and the central bank to leave its key policy rate unchanged at 12 per cent for the next two months.

An IMF team of its staff members prepared the report for the 2011 Article IV Consultation and Proposal for Post-Programme Monitoring, following discussions with Pakistani officials in November.

The report was completed on January 23, and released this month. The report suggested the government to prepare a contingency plan pointing out the risks to the country's economic outlook. It stressed on comprehensive fiscal reforms and greater central bank independence.

The IMF identified the failure of loose monetary policies by the central bank to spur economic growth, as it continued to feed double-digit inflation.

The headline inflation rose 10.1 per cent in January over the same month of last year. The IMF executive directors urged the government to tighten its "too accommodative" monetary policy.

Under IMFs pressure, the government maintained one of the world's highest benchmark interest rates, in an economy hurt by inflation, terrorism and falling foreign investments.

The country ended its $11.3 billion IMF loan programme incomplete on September 30. The central bank's monetary policy for October-November 2011 that cut the discount rate by 150 basis points to 12 per cent was a departure from its previous policy of monetary tightening that was pursued over the past few years under IMF pressure.

Influenced by the warning and findings of the IMF report, the State Bank of Pakistan (SBP) announced its monetary policy for next two months on February 11 and left its discount rate unchanged. The SBP had also kept its benchmark interest rate unchanged at 12 per cent in its monetary policy announced on Nov. 30 last year for the next two months in a move to avoid the emerging risks to macroeconomic stability.

The central bank warned that the challenge faced by the economy was to finance the fiscal and current account deficits. Current account deficit reached $2.2 billion in first half of current fiscal year ending June, which is already higher than SBP's full year projection made at the beginning of current fiscal. The central bank warned that risks to external position heightened due to a larger than expected external current account deficit and continued decline of financial inflows.

The analysts fear that the country could face a balance of payments crisis amid a growing current account deficit, which is likely to worsen in coming months in view of repayments of $8 billion IMFs loan. The country has to repay about $1.1 billion to the IMF before June 30.

The central bank kept the policy interest rate unchanged at 12 per cent in the wake of persistent double-digit inflation. The consumer price index (CPI) inflation is expected to rise further in coming months as international oil prices rise. The oil prices are linked with international crude prices, which presently hover above $117. The central bank expects the average inflation to remain in the range of 11 to 12 percent in FY12.

SBP's governor Yaseen Anwar warned that the inflationary pressures have not eased significantly and described the increases in electricity and gas prices, impact of exchange rate pass-through and substantial government borrowings from the banking system, as the main reasons for double-digit inflation.

Mr. Anwar asked the government to reduce its borrowing to reduce the rising inflation. The government has so far borrowed Rs444 billion from the banking system, including Rs197 billion from the central bank, an amount considerably higher than the yearly financing requirements of Rs293 billion envisaged in the current fiscal year budget.

The government borrowing from banking system increased by 136 percent to Rs813.79 billion up to January 20 against Rs344.58 billion a year ago, according to the central bank. The government domestic debt and liabilities surged by 28.42 percent to Rs7.05 trillion by December 2011 as against Rs5.49 trillion at the end of same month last year.

The provisional estimate of fiscal deficit for the first half (July-Dec) of current fiscal, from the financing side, shows a deficit of Rs532 billion, or 2.5 per cent of GDP. Over the past 10 years, the deficit has always been higher in the second half of a fiscal year by at least 0.5 per cent of GDP.

The business community considers the current policy rate at 12 percent too high and responsible for sluggish economy, falling investments, growing job and export losses.

Local businesspersons urge the government to salvage the industry by bringing the interest rates down to six to seven per cent. They contend the reversal of monetary easing would have far-reaching and disastrous implications for the industry and jobs and pull down the entire economy.

The central bank's tight monetary policy could not tame the soaring inflation, yet it did asphyxiate the economic growth. The country's economy witnessed a growth of 2.4 percent in the last fiscal year, slower than an earlier target of 4.5 percent.

The inflation rate during the fiscal year 2010-11 remained over 14 percent. High interest rate has been the key reason behind the low growth in the industrial production and closure of many industrial units.

In the last fiscal year, the manufacturing sector saw only a three per cent growth. The tight monetary policy has not allowed the private sector to play its key part as engine of growth. High borrowing costs discouraged the demand for private sector credit, which in turn decreased private investment adversely affecting the prospects of economic growth.

Critics say that a meager drop in discount rate will make no difference as the rate is still one of the highest in the world, hence it should have been reduced by three or four per cent.

The double-digit interest rate has so far been unable to control double-digit inflation, which has become a serious problem for the country where up to 40 per cent of its 170 million populations live below poverty line.