MONEY WEEK: what's in offing?

Money supply which virtually remained unchanged in the first quarter of this fiscal year, up by 6.5 percent (Rs 335 bn) in the second quarter is a good omen for the economy which is in the slow process of recovery after a dismal performance last year. To add more, this surge in liquidity primarily emanated from the backbone of economy - private sector.
Government borrowing for fiscal support also jumped three folds in this quarter; however, essentially muted foreign inflows forced the government to borrow more from the banking system. Nonetheless, government borrowing from commercial banks was even higher in the first quarter versus the second quarter.
After private sector, the most profound, but worrisome change, was in the net foreign assets. The delay in US coalition support fund, silence from friends of Pakistan (FoDP), and falling FDI had not let the economy recover as swiftly as one would have liked. NFA, after increasing by Rs 132 billion in Jul-Sep, fell by Rs 15 billion during October-December period.
The hopes of this nascent economic recovery in the second half of this fiscal year are tied with foreign inflows. The materialisation of over Rs 150 billion, allocated from the FoDP in the development head for FY10 fiscal budget seems to be a daydream which doesn't come true that often. This will not only circumscribe the development expenditure but would potentially slip the fiscal deficit further.
However, over $750 million (Rs 62 billion) received in bridge financing for fiscal support from IMF slightly healed the wounds and allowed the government to spend on prioritised social spending--like on IDPs and other poverty eradication programs. But, most likely, the long-term development projects will be shelved for this fiscal year.
Let us not delve into the tale of development spending, rather envisage the monetary movement in the remaining half of this fiscal year. The State Bank in its recently released quarterly report projected M2 to grow by 12-13 percent this year. With 6.5 percent growth already achieved in first half; the money supply is expected to increase by Rs 300-325 billion in January-June period.
Interestingly, all the growth in money supply for the first half was confined to the second quarter. And, if the foreign flows remain muted in the second half, the recovery for private sector witnessed in the last quarter might be reduced to half in the coming quarters.
Hence, to spur the recovery process in the second half, it is imperative to have foreign funds. The resolution of US officials' visa issues and other small conflicts to facilitate the US coalition support fund and other military support funds is necessary for private sector credit growth.
Unlike the first quarter, where low demand and reluctance of banks to lend was the root cause for fall in private credit, excessive government reliance on commercial banks by borrowing Rs 87 billion crowded out the private investment in the last quarter. And this trend will be more vocal in the coming quarters, as government expenditures are inflexible amid fall in domestic savings.
Any foreign flows are not likely to change the overall money growth as significant as they change the course of money flow. For instance, receiving $500 million (Rs 42 billion) from coalition support fund will reduce government borrowing pressure from the central bank and commercial banks and will channel domestic liquidity towards the private sector. The multiplier effect will do the rest.
Also, by reducing the domestic borrowing pressure of fiscal deficit, it will facilitate the central bank to give more weight to weak private sector credit for making its policy rate decision in its upcoming reviews. The SBP, which reduced its policy rate by 150 bps in a staged manner during 1HFY10, has the room to further revise it by 100 bps in second half. However, the direction of international commodity prices and foreign flows will be the key to its decision.

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Rs (bn)                         Q1        Q2        H1

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NFA                        131,894   (14,688)  117,203

Fiscal Borrowing            44,126   118,140   162,266

from SBP                   (73,555)   30,741  (42,814)

from comm banks            117,681    87,399   205,080

Credit to private sector   (78,319)  187,558   109,239

M2                          (1,263)  335,430   334,167

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KEY MONETARY AGGREGATES

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Rs (mn)                                       AS OF

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                                    2-Jan    26-Dec     Change

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Currency in Circulation           149,082   167,638   (18,556)

Total Demand & Time Deposits      184,440    99,053     85,387

Broad Money (M2)                  334,167   267,045     67,122

NFA                               117,206    75,541     41,665

NDA                               216,961   191,503     25,458

Net Government Borrowing          152,639   253,541  (100,902)

Borrowing for budgetary support   162,266   264,484  (102,218)

from SBP                          (42,814)   58,076  (100,890)

from scheduled banks              205,080   206,408    (1,328)

Commodity operation                (8,300)   (9,612)     1,312

Credit to non-govt sector         201,976   146,180     55,796

to private sector                 109,239    65,102     44,137

to PSEs                            93,543    81,858     11,685

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Source: SBP

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