Inflation is down, but signs are obvious that original target is not achievable and a rising inflationary trend in the last two-quarter of FY 2009-10 will aggravate, as the advantage of base rate effect would vanish. Fiscal slippage remains a worrying factor due to revenue shortfall and therefore higher deficit is a fair possibility.
Hence, by the end of the current fiscal year inflation is likely to hit 13 to 14 pct and risk discount rate hike will reemerge. Rise of Oil prices in the global market does not help the cause, another circular debt is piling up and Rs 80 billion is required to meet the shortfall. The budgeted oil price of $69.70 may not be sustainable if international oil prices continue its current up trend.
Import of one million tons of Sugar would roughly cost over US Dollar half - a - billion. Fall in rice price in the int''l market due to good crop means low demand and low prices abroad. Pakistan is already holding roughly 1.5 million tons of old stock. This also means that rice traders are at a risk of unloading their rice holdings and hence, they would require extension of their bank financing.
One ponders that since Fx reserves of USD 14.48 billion, which is good enough to meet imports payment for next 5 to 6 months, then why do we need more IMF money with tough conditionalities attached to it, as IMF money cannot be utilised for domestic spending?
What is more a worrying factor is that the external debt continues to surge and likely to surpass USD 55 Billion by the end of the calendar year without any known repayment plans? As Global interest rate has bottomed out, the risk is that borrowing will become more costly with the emerging signs of global future interest rate hike. Had this been grant conditional release of funds would have made better sense.
Rupee Liquidity is one of the major problems faced by the economy. Banks and financial institutions are unable to generate new deposit portfolio. Foreign investments are not enough to provide the much needed respite. Therefore, severe fiscal measure is the only recipe to counter the odds.
Non essential import led by Large Scale Manufacturing (LSM) growth, risks more damage than fixing the economy, due to acute shortage of foreign exchange. Our economy cannot sustain current account and trade deficit for ever. Surge in remittances has provided some support to economy due to joint effort by SBP & Ministry of Overseas and a drop in inflow is unaffordable.
Though we have faith in our economic managers negotiating with the IMF team, but a big opportunity has been missed out, as it was unable to convince IMF that the country not only need its support to manage its balance of payments, but the economy desperately needs Rupee liquidity to stimulate.
Therefore, part of the funding should have been allowed for domestic stimulation and allow to bring down the fiscal deficit gradually instead of sharp cut in deficit and simultaneously be allowed to slash discount rate by 3 pct to 4 pct. Pakistan had a strong and genuine case of low growth, as one of the major causes of unrest in the country is due to poverty, price hike and rising unemployment.
Quantitative easing and low interest rate environment globally is evident of the fact of economic recovery and Pakistan''s economy faces no different situation. Perhaps, it is late to demand for fiscal space for two reasons, as base effect will soon be shifting its stance form-descending mode to ascending mode, which means inflation will start to creep up soon and secondly due to a clear shift in global interest rate trend towards tightening.
ECB announced that it is withdrawing some of its liquidity operation. Bank of England slowed its pace of bond purchase. Bank of Japan had decided to end its purchase of corporate debt by end of December. Though Fed in its latest FOMC announcement signalled low interest for next 6-month but hinted that earlier rate rise possible.
Theoretically, inflation did fall sharply due to tightening measures and helped by the base effect, but from a common man''s perspective falling inflation is not at all helpful.
It is more due to number game and is debatable as the argument is that despite sharp fall in inflation prices of daily essentials such as, flour, rice, sugar, lentils, vegetable, fruits, electricity, petrol, house rent and real estate is on constant rise during last couple of years. The real cause is because of too much fiscal space due to excessive Govt borrowings and rising support price of food commodity.
Therefore, it makes little sense to think of price decline of essential food items when the support price is on constant rise. Shifting of bank advances to investments may be a good accounting strategy, it also provides some room to lending, but it is a temporary solution and does not give the required space to bank lending.
Moreover, banks are comfortable by placing their funds in less riskier liquid Govt securities instead of providing credit to the private sector. Rising Non-Performing Loans (NPL''s) is not helping the cause. It is extremely important to understand that our economy is over levered by almost three and half times, which is creating pressure on our financial system.
The bitter truth is that our economy is surviving on borrowed money and the lingering trade gap is the biggest threatening factor, which needs to be filled regularly. Hence, if we are unable to get support from foreign lenders the economy would sink further. Leveraged economies cannot afford inflated price levels and are supposed to tighten the money supply and cannot afford easing if interest rates.
Economically, there is a weak case favouring of a Discount Rate cut. But there could a bleak chance and last hope of cut due to excessive demand from the business community possibly in the coming Monetary Policy Statement (MPS) originally due in three weeks time.
Certainly not after that because the inflation number of later period of 2nd quarter of FY 09-10 due in January-February would be higher. The Central Bank often provides signal to the market and recently it has shown no intention of Discount Rate cut. In its last T/bills auction it shaved off the yields by 5 basis points.
This was mainly because the banks offered the target amount at lower rate. The proof is in the pudding is there as it could have raised excess money in one single tenor, ie in 12 months, but it preferred to lift tiny amounts in 3-month and 6-month by slashing 5 basis points and provided the benchmark.
Further evidence can be found from SBP''s last week''s mopping decision through open market open (OMO), when it decided to lift a mere amount of Rs 8 billion at 11.5 pct for 2 days despite availability of window corridor facility, where banks could have dumped money at a cheaper rate of 10 pct.
Pakistan Investments Bond (PIB) auction is due on Wednesday November 11, against zero maturity the target amount is Rs 15 billion. Corporate sector''s interest would be keenly watched. A large insurance company that normally participates and is the biggest investor in PIB has invested a good part of its liquidity in TFC''s. Mutual funds and asset management companies are not sitting liquid and year end closing demand for balance sheet purpose will keep pressure on Rupee.
Estimates are that withdrawal for animal sacrifice during Eid is roughly about Rs 75 Billion. SBP has so far injected Rs 85 billion to meet the liquidity of the banking system. 10 years PIB, which is a most commonly traded Govt security in the interbank market, is a good long term investment paper, but the drawback is that it is not a very liquid instrument for a decent amount of Rs Half-a Billion at one go.
There are quite a few banks and financial institutions that are stuck up with purchase of 10-year bond holding ranges between 11.5 pct to 12.5 pct yield, as they are held under the trading head, which means loss as the yield is above 12.5 pct.
There is big risk that if discount rate is not slashed in next MPS, PIB yield would soon jump beyond 13 pct and the yield could settle somewhere around 13.5 to 14 pct. Quarter three and quarter four of FY 2009-10 would be quite challenging, as sufficient liquidity will be required.
T/bills maturing amount in quarter three is Rs 346 billion and quarter four would witness a maturity of Rs 309 billion. Seasonal financing will be due in 4th quarter. By then it would be interesting to see if the KIBOR rates eases, as six-monthly return on TFC''s worth Rs 210 billion against Circular Debt will be fixed. Therefore, there is every reason to believe that rate cut is not a distinct possibility.
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