The State Bank blinks

Looks like it’s back to business as usual at the State Bank. After a bombastic annual report that raked the government over the coals for its ‘governance’ failures, the newly-released first quarterly report has reverted to the mealy-mouthed language typical of State Bank publications. Have the ‘governance’ failures outlined in the Annual Report been fixed? Or is the quarterly report too polite a forum from where to stir such controversies?

Having pegged the country’s economic difficulties on ‘governance’ failures, one would expect that the State Bank would track the governance record closely in subsequent pronouncements.  Instead we have a press release accompanying the first quarterly report with the tagline: “Government making headway towards improving its finances”.

The release points out an improvement in revenue collection in the first quarter, saying the budget deficit dropped by 0.3 per cent of GDP compared to last year. A drop is good news in a time when all that goes up rarely ever comes down — so on the face of it a reduction of the quarterly budget deficit does sound like good news.

But even the most obsequious choice of words cannot hide the most basic realities. The central bank preferred to open its press release on an optimistic note, delivering its otherwise grim assessment with a cheery smile. But a closer reading of the report itself shows the tenuous ground beneath this optimism. Of course it takes an exegetical treatment usually reserved for the Old Testament to extract any meaningful sense out of State Bank publications, and this quarterly report is no different.

Take the drop in the quarterly budget deficit target for instance. The chapter on fiscal policy explains the drop with these words: “The strong growth in tax revenue was largely due to import-related sales tax, which was supported by higher unit value of crude oil and fertilisers during the quarter.”

It’s fair to say that revenues have grown in the first quarter of this fiscal year, but it’s misleading to present this data as evidence of the “government making headway towards improving its finances”.  The State Bank did not withhold its caveats in the annual report so one is entitled to wonder why they’re doing so now.

The report is silent on the predicament of the public sector enterprises (PSEs). This is surprising considering how much noise the annual report had kicked up about these entities and their fiscal burden, and also surprising because “settlement of circular debt of power sector PSEs and public procurement agencies resulted in a substantial Rs 572.2 billion increase in the stock of total debt & liabilities, during the first five months of FY12”.

Have the governance weaknesses at the PSEs, that the annual report screamed about, been resolved?  Has the State Banks voice been ignored?  We’re not told, in spite of the continuing crushing fiscal burden that these enterprises place on public finances, the State Bank chooses to drop that potato altogether in this report.

On the external sector, the picture gets truly grim. True to form, the accompanying press release begins its paragraph on the external sector by blowing some sunshine about last year’s strong numbers before coming around to the business at hand: “The pace at which the current account deteriorated during the first quarter of FY12 took many by surprise”, going on to mention that in September 2011 alone, the current account deficit touched one billion dollars.

But this isn’t even the beginning of it. The report unhappily notes a “$1.9 billion reduction in SBP’s liquid foreign exchange reserves from July to Nov 2011”. The outflow of reserves drained market liquidity, so the SBP pumped over Rs300 billion into the banking system through what they call open market operations (OMOs). The sums involved in the outflows and market management operations are matched only by the government’s borrowing requirements during the same period.

And it gets better. About the worsening external account, the report says it was “on the cards” but the “timing and magnitude was unexpected”.  If it was “on the cards”, gentlemen, may we ask from where you quarried your optimism in the July and October 2011 Monetary Policy Statements, specifically in October when you described the foreign reserves as “comfortable?” Or was that comfort “on the cards” too?

“Pakistan must make all efforts to ensure the resumption of financial inflows,” the report declares after noting that export proceeds will continue to drop, leaving us with remittances as the last surviving inflow through which to finance a growing import bill.

The ramifications of this should not be underestimated. The report points to two areas of vulnerability as forex reserves continue declining: market liquidity and the currency. In both cases the central bank has had to intervene to stabilise things, with large scale OMOs and currency interventions that depleted SBP reserves. But how long can the State Bank hold out like this?  One lesson from the crisis of 2008 teaches us that continuously declining reserves at some point can trigger panic withdrawals and quickly turn into a financial and banking crisis. We don’t know where that point lies, and we sure don’t want to find out from experience. When one recalls those days, one understands what the State Bank means when they say “make ALL efforts” to resume financial inflows.

Deteriorating terms of trade is only the first step in an adverse external environment that everybody knew we were entering as far back as July. The next step is external debt service obligations that get going in a big way in February with a $1.2 billion payment to the IMF, rising to $4.1 billion before end June, according to the report.

Caught between growing government borrowing and depleting reserves, the State Bank is standing in a very unhappy place these days.  Given the seriousness of the situation, one wonders why they’re choosing to back away from the heady tone adopted in the annual report. Did a messenger arrive bringing clarity regarding the government’s compulsions?

Published in The Express Tribune, February 2^nd, 2012.