Monetary policy review
SBP has admitted failure in attempt to kick-start expansion of private sector credit and to trigger investment, growth
DESIGN: ESSA MALIK/FILE
No one likes to admit failure. No one likes to accept defeat. But it seems that is exactly what the State Bank of Pakistan (SBP) has done. After going out on a limb and reducing the policy rate by over 450 basis points over the past 18 months, it seems the regulator has admitted that the strategy has failed.
In the latest monetary policy announcement, the regulator has kept the policy rate, or in simpler terms, the interest unchanged at 9.5 per cent. Consumer Price Index inflation went to a low of 6.9 per cent last year but has now once again surged to 8.1 per cent. Core inflation is also inching back up and it is very likely that it will have hit double digits by the time the next monetary policy announcement is due.
The basic premise that the SBP had adopted was quite simple. It never openly admitted to this but by drastically reducing the interest rate, it had hoped that banks would find it unattractive to lend to the government and, in doing so, had hoped to achieve two things. On the one hand, it had hoped that this might have some kind of a restrictive effect on runaway government borrowing. On the other hand, it had hoped that the banks would instead start lending to the private sector.
It has always been obvious that the task of containing the size of fiscal deficit and government’s borrowing requirements from the banking system is becoming more and more difficult, but it is now equally obvious that despite all its efforts, the SBP has been unable to gain any kind of control over this.
The year-on-year growth in broad money, on average, has been almost 18 per cent against average GDP growth of less than four per cent. This has left a very large gap for inflationary pressures and the signs are already there with inflation once again creeping towards double digits. Many fear that energy costs are not accurately represented in the calculation of inflation, which is why inflation is not already in double digits.
In comparison, growth fiscal borrowings from scheduled banks was 41.3 per cent on January 25. Over the last four years, fiscal borrowings from the scheduled banks for budgetary support have grown by an average of around 60 per cent.
The average growth in credit to private businesses, on the other hand, has only been four per cent during the same period. The end result is that the domestic debt has risen by 25.6 per cent on average, while private fixed investment has contracted by 9.4 per cent in the economy.
The SBP, without actually saying so, has admitted failure in its attempt to kick-start expansion of private sector credit and to trigger investment and growth as a result of cuts in the interest rate. This rationale had been its main argument for lowering the interest rate.
That rationale was absent and quietly swept under the rug in the latest monetary policy announcement.
However, it would be unfair to place the entire blame for the lack of private sector credit expansion on the central bank. Other factors like energy shortages, the poor law and order situation and the unwillingness of industrialists to invest in this situation, or for banks to lend in a stagnant economy are probably more to blame for the non-existent demand for credit.
The unchanged interest rate was not a surprise for anyone. What did catch many by surprise was the narrowing of the interest corridor by 50 basis points from seven to 6.5 per cent and the indication that the SBP was going to limit Open Market Operations (OMO) that have been a thorn of contention between the IMF and the Pakistan government, which wants a new agreement. In the past year alone, the regulator has effectively pumped close to half a trillion rupees into the market through OMOs.
The indication that this may be coming to an end could be a condition set by the IMF if there is to be any chance of a new agreement. But whether that really is the case, is anybody’s guess.
Published in The Express Tribune, February 10th, 2013.
In the latest monetary policy announcement, the regulator has kept the policy rate, or in simpler terms, the interest unchanged at 9.5 per cent. Consumer Price Index inflation went to a low of 6.9 per cent last year but has now once again surged to 8.1 per cent. Core inflation is also inching back up and it is very likely that it will have hit double digits by the time the next monetary policy announcement is due.
The basic premise that the SBP had adopted was quite simple. It never openly admitted to this but by drastically reducing the interest rate, it had hoped that banks would find it unattractive to lend to the government and, in doing so, had hoped to achieve two things. On the one hand, it had hoped that this might have some kind of a restrictive effect on runaway government borrowing. On the other hand, it had hoped that the banks would instead start lending to the private sector.
It has always been obvious that the task of containing the size of fiscal deficit and government’s borrowing requirements from the banking system is becoming more and more difficult, but it is now equally obvious that despite all its efforts, the SBP has been unable to gain any kind of control over this.
The year-on-year growth in broad money, on average, has been almost 18 per cent against average GDP growth of less than four per cent. This has left a very large gap for inflationary pressures and the signs are already there with inflation once again creeping towards double digits. Many fear that energy costs are not accurately represented in the calculation of inflation, which is why inflation is not already in double digits.
In comparison, growth fiscal borrowings from scheduled banks was 41.3 per cent on January 25. Over the last four years, fiscal borrowings from the scheduled banks for budgetary support have grown by an average of around 60 per cent.
The average growth in credit to private businesses, on the other hand, has only been four per cent during the same period. The end result is that the domestic debt has risen by 25.6 per cent on average, while private fixed investment has contracted by 9.4 per cent in the economy.
The SBP, without actually saying so, has admitted failure in its attempt to kick-start expansion of private sector credit and to trigger investment and growth as a result of cuts in the interest rate. This rationale had been its main argument for lowering the interest rate.
That rationale was absent and quietly swept under the rug in the latest monetary policy announcement.
However, it would be unfair to place the entire blame for the lack of private sector credit expansion on the central bank. Other factors like energy shortages, the poor law and order situation and the unwillingness of industrialists to invest in this situation, or for banks to lend in a stagnant economy are probably more to blame for the non-existent demand for credit.
The unchanged interest rate was not a surprise for anyone. What did catch many by surprise was the narrowing of the interest corridor by 50 basis points from seven to 6.5 per cent and the indication that the SBP was going to limit Open Market Operations (OMO) that have been a thorn of contention between the IMF and the Pakistan government, which wants a new agreement. In the past year alone, the regulator has effectively pumped close to half a trillion rupees into the market through OMOs.
The indication that this may be coming to an end could be a condition set by the IMF if there is to be any chance of a new agreement. But whether that really is the case, is anybody’s guess.
Published in The Express Tribune, February 10th, 2013.