Sep 17 - 23, 20

The Monetary Policy decisions by SBP has always remained under speculation whether the rate will be increased or decreased considering the macro economic indicators particularly inflation. The international oil prices continue to be volatile and not expected to be maintained below US Dollar 100 per barrel since high oil prices translates into higher GDP of OPEC. Pakistan has witnessed consistent revisions in oil prices as the Government uses this tool for revenue generation in the form of tax. Though inflation is effected due with supply side issues, one of the core reasons is SBP is government borrowing which have yet to be reduced. If oil prices decrease, any such decrease will be negated through the devaluation of rupee against the dollar which is likely to increase the import bill and causing inflation. CPI as on July 2012 stood at 9.60% with electricity, fuel and gas accounting for 29 percent of the CPI. This is the first time during CY12 that CPI is witnessed in single digits.

Based on the latest Monetary Policy decision, SBP has reduced the policy rate from 12 percent to 10.5 percent which would assist in lowering of the benchmark lending rate, T-Bill yield and would encourage lending by the banks to the private sector. SBP in light of lowering of inflation has given an incentive to the economy to boost the private sector through expansion of credit with hopes to increase production and GDP growth. A source for liquidity pressures in the economy is sluggish economic growth and foreign direct investments which could substitute low tax base. SBP has stressed time and again that the government must devise fiscal and energy sector reforms and plan foreign financial inflows to mitigate uncertainty and pressure on reserves.

With a poor tax base and imports double of exports, the only major source of funding for the government is borrowing from the private sector, outstanding stock level reaching of Rs. 1,660 billion. The year-on-year growth in the private sector credit was only 4.2 percent. Since government securities yield a healthy risk free return, banks prefer financing the fiscal deficit through investment in fixed income securities rather than focus more on taking risk and extend private sector credit which declines investment to GDP ratio. With the new policy rate is place and T-Bill yield ranging between 11.2 percent and 11.5 percent along with reduction in KIBOR, it is expected that the lower benchmark rate will encourage the consumers as well as the private sector to focus on advancing of new credit in addition to yielding the maximum out of the current bank advances portfolio. Through the benefit will assist in reduced finance cost, it is yet to be seen how it will encourage off-take of credit rather than investments in fixed income securities.

During the period of July 2011 to March 2012, GDP was recorded at 4.3 percent and is expected to remain at 4.7 percent during FY13. The GDP growth rate is slow and ideally would have expected to be around 6 percent if the economy was not hampered with instability. There is immense potential in the market for long term investments, however, the reduction in the Policy rate will show results in the next 6 months whether advances have been increased through reduction in rate. At this point, it is difficult to ascertain the total demand of credit in the country for consumers and the private sector who are eligible for such credit keeping with the risk factors for each. The challenge is to change the mindset of banks to move from current status quo to lending and disbarments.

The competition in the banking sector is intense with smaller and midsized banks pushing to pull deposit from larger banks offering competitive and attractive rate on liability products. SBP time and again has encouraged banks to provide a healthy return to its depositors whereas banks strive to lower the rate of return which in turn increases the banking spread to improve profitability. Since the return on deposits is a cost to the bank, in an ideal situation, no bank would like to incur this cost to squeeze its spread. Due to low returns, depositors find alternate mediums for investment by depositing funds with National Saving Schemes (NSS), Mutual Funds and Stocks. NSS has always been under fire by the banks for offering rates better than what banks offer. The government is further pushed by senior bankers to keep the rate at par with those offered by the banks. With the reduction in the Policy Rate, returns on NSS have also reduced, however, still continue to be higher than those offered by banks

The challenge for SBP with the Monetary Policy is to reduce inflation and encourage private sector lending alongside an attractive rate of return for depositors to counter rise in inflation. The Monetary Policy cannot work in isolation considering external shocks e.g. international oil prices, recessionary impact, devaluation in interest rates or government borrowings. Pakistan is a net importer therefore any devaluation in the exchange rate against the dollar will make imports expensive and put further pressure on the reserves. Though exports due to such devaluation are expected to grow, however considering rise in input cost, such differential may be negated making prices unattractive for the export markets.

An encouraging sign for the economy are worker remittance which average more than USD 1 billion each month, however FDI has decreased and expected to be less than USD 1 billion at the close of the year keeping with political uncertainty and law and order issues. The country recorded worker remittances of US Dollar 13.2 billion in FY12 as compared to US Dollar 11.2 billion in FY11 seen as a positive sign. It is expected that the inflow of worker remittances will reach USD 15 billion by FY13 through the Pakistan Remittance Initiative (PRI) scheme recently launched. Foreign investors take a strict view on Pakistan keeping into account the country risk, therefore, if domestic investors are hesitant with investments, it is unlikely that foreign investments would flow.

In order to curtail inflation and finance government budgetary deficits, SBP's decision on the monetary policy alone cannot work in isolation unless such policies work hand in hand with fiscal decisions to increase tax base and eliminate transactions which run parallel to the economy. The government's total expenditure to GDP is 19 percent whereas revenue to GDP is 12.5 percent creating a mismatch which needs to be filled through tax base rather than borrowing from the banking sector. Though decisions to maneuver the economy also rests in the hand of the government, what will eventually help resolve the situation is high degree of integrity and accountability for public service across the board to address every issue faced by the people in the economy to better their lives.