While leaving policy rate unchanged at 9.5 percent, the State Bank of Pakistan has strongly hinted that it could be forced to reverse its monetary stance in case the present drift persists. Addressing the media after issuance of monetary statement on Friday, Governor SBP Yaseen Anwar said that in the wake of rising risks to macroeconomic stability and in the absence of structural reforms that could have supported price stability and growth in medium term, it may be difficult to continue with the same monetary policy stance.
---- Food inflation (YoY) has increased to 8.1 percent in January 2013 from 7.7 percent in the previous month
---- The 20 percent trimmed mean measure of core inflation has increased to 9.9 percent (YoY) in January from 9.2 percent in the previous month
---- Led by a decline in import payments, the external trade deficit has narrowed by 3.6 percent during H1-FY13
---- Fiscal deficit in Q1-FY13 was mainly financed through borrowings from scheduled banks
---- Stock of government domestic debt has increased by Rs 691 billion during H1-FY13
---- Interest payments on domestic debt have shown an annualised growth of 42.3 percent during H1-FY13 as compared to the first half of FY12
According to him, SBP has to be forward looking and take steps to meet the emerging challenges. "The two main challenges, from the point of view of SBP, are managing the balance of payment position and containing the resurgence of inflationary pressures," Anwar added.
He said the macroeconomic conditions weakened during H1-FY13 despite improvement in some key indicators. The CPI inflation came down quite sharply till November 2012 but has increased since then. Further, the external current account posted a surplus during H1-FY13 but the foreign exchange reserves have declined, predominantly due to IMF repayments. "The non-tax revenues of the government received a boost after receiving Coalition Support Fund (CSF) of 0.7 percent of GDP during H1-FY13 yet the fiscal deficit is expected to miss the budgeted target by a wide margin," he added.
Responding to a sharply declining inflation and assigning a higher weight to contracting private investment, he said: "SBP lowered its policy rate by a cumulative 450 basis points over the last 18 months. SBP also ensured that both the money and the foreign exchange markets remain stable. It also introduced certain measures to improve the liquidity management and financial intermediation aspects of the banking sector."
SBP Governor said the fundamental weakness in the balance of payments is the continuous decline in the net capital and financial flows. "There has been a net outflow of $539 million in this account during H1-FY13. In addition, the SBP has retired $1.3 billion of IMF loans during the first seven months of FY13. Thus, despite an external current account surplus of $250 million in H1-FY13, the foreign exchange reserves of SBP have declined to $8.7 billion as on 31st January 2013 from $10.8 billion at end-June 2012."
Anwar said the surplus in the external current account during H1-FY13 was primarily due to the receipt of $1.8 billion in the CSF. A marginal improvement in the trade balance and a robust growth in workers'''' remittances have also helped the external current account balance, mitigating pressure on the balance of payments position. "SBP expects the external current account deficit to remain below 1 percent of GDP for FY13. This is despite little expectation of receiving proceeds of approximately $850 million from the auction for 3G licences," he emphasised.
He observed that in view of the declining trend in financial inflows and a very low probability of receiving the budgeted privatisation inflows of $800 million in FY13, the challenges on the balance of payments position are unlikely to subside. "Further payments of $1.7 billion of IMF loan in the remaining five months of FY13 and $3.2 billion in FY14 do not help the situation either. While the economy has sufficient reserves to meet its debt obligations, the real challenge is to manage the market-driven sentiments," he added.
SBP Governor was of the view that a volatility in the foreign exchange market can have implications for the inflation outlook due to potential feedback from exchange rate changes under prevailing conditions. "This is why the SBP has intervened in the foreign exchange market in a calibrated manner to ensure its smooth functioning. It is important to remember that only a consistent increase in foreign exchange can ensure stability in the market," he added.
Anwar said the CPI inflation has already risen in the past two months; from 6.9 percent in November 2012 to 8.1 percent in January 2013. The core inflation measures are also inching towards double digit figures again after coming down to a single digit. The average inflation for FY13 is projected to remain between 8 and 9 percent; well within the target of 9.5 percent. It is the medium-term inflation outlook that needs to be assessed carefully. A rising trend in monetary aggregates is a key indicator of medium term inflationary pressures. "SBP expects M2 growth for FY13 to be close to 16 percent. Similarly, due to a weakening external position and rising debt levels in the economy, anchoring expectations of inflation at low levels would be a challenging task," he added.
Further, he said the year-on-year growth in M2 on 25th January 2013 was 17.3 percent while that in fiscal borrowings from the scheduled banks was 41.3 percent. He said that over the last four years fiscal borrowings from the scheduled banks for budgetary support have grown by an average of around 60 percent. The average growth in credit to private businesses, on the other hand, has only been 4 percent during the same period. The end result is that the domestic debt has risen by 25.6 percent on average while private fixed investment has contracted by 9.4 percent in the economy, he added.
Anwar said that the fiscal authority retired Rs 399 billion in Q1-FY13 and borrowed Rs 183 billion in Q2-FY13 from the SBP. "The inability to keep these borrowings at zero within a quarter is a contravention of the SBP Act and an important factor behind an imperfect control over inflation expectations by the SBP," he observed.
SBP Governor said the growth in credit to private businesses has been higher during H1-FY13 compared to the corresponding period of last year. Private businesses availed Rs 154 billion during H1-FY13 as opposed to only Rs 85 billion during H1-FY12. He said, that this could be because of declining interest rates and moderation in accumulation of Non Performing Loans (NPLs). "Since the beginning of FY13, the average lending rate has decreased by 204 basis points to 11.3 percent in December 2012. Similarly, the NPLs to advances ratio has declined to 15.5 percent in September 2012 from 16.7 percent in September 2011," he said.
He said the GDP growth in Pakistan is expected to remain just below 4 percent in FY13. "The fundamental reasons for this likely outcome are the prolonged and severe crisis in the energy sector and worsening law and order conditions in the country," he explained.
Anwar noted the main reason for large borrowing requirements from the banking system is the structurally high fiscal deficit and low level of external financing the estimates from the financing side of fiscal accounts indicate a deficit of 2.7 percent of GDP during H1-FY13. "Given a growth of 8.8 percent in the tax collection of the FBR during the first five months and strong seasonality of higher fiscal deficits in the second half of a fiscal year, the budgeted fiscal deficit target of 4.7 percent of GDP for FY13 is projected to be missed by a wide margin," he anticipated.
The SBP Governor said the sources of consistently high fiscal deficit are well known - low tax base and evasion together with subsidies to the loss-making Public Sector Enterprises (PSEs) and the energy sector. "Due to a continuous increase in short term borrowings at a very rapid pace, the share of interest payments in current expenditures has also risen quite sharply in the last few years. Thus, comprehensive initiatives are required to make the fiscal position sustainable and restore macroeconomic stability," he concluded.
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