The State Bank of Pakistan (SBP) has kept the policy rate unchanged at 6.5 percent. In the previous policy it had reduced the ceiling of interest rates corridor by 100 bps to seven percent. It had also introduced a new target rate which it termed as policy rate, at 50 bps below the ceiling rate. This target rate is the policy rate and SBP kept it unchanged this time around, at 6.5 percent while making the ceiling rate irrelevant for market interest rates. Hence, effectively the previous easing was of 150 bps and no change this time around.
The decision was as per expectation of the market; however a few circles had recommended a cut of 50 bps. The external economists in the Monetary Policy Board advocated for a cut to spur private credit which has not yet picked up despite 300 bps (or 350 bps) easing since November 2014. While the other board members ruled this out - they opined any easing would have slashed the debt servicing cost of government as private credit is at bay owing to various other reasons which are irrelevant to interest rates.
That is the point! The objective of easing monetary policy stance is to spur private credit and boost economic growth; otherwise it''s a futile exercise. Why is it not happening? The impact of the change in MPS comes with a lag of 6-18 months and the easing cycle started in November, so it''s expected to yield results soon. The monetary expansion has already started in the last quarter and it will grow further in FY16.
The question is whether it will create demand for private credit, or not? So far it hasn''t -private credit grew by Rs209 billion in FY15, as compared to Rs371 billion in FY14. The plausible reason to explain this anomaly is government''s shift of fiscal borrowing from the central bank to scheduled banks which crowded out private credit. In FY15, the government borrowed Rs1.3 trillion from commercial banks while this tally was mere Rs164 billion in FY14.
Why is this happening at a time when the fiscal deficit is trimming? Pressure from the IMF is to blame - to meet fund''s conditionality of net zero quarterly borrowing from central bank, government proactively shifted the burden from SBP - it retired Rs434 billion in FY15 as compared to Rs160 billion borrowed in the previous year. The net retirement was Rs594 billion Fresh requirements amid stagnant external financing sources have raised the borrowing from scheduled banks'' manifold. Hence, the space for private sector lending has been squeezed.
The crowding out of private investment is not a new problem at home; growth is being eroded due to it since 2008. So, why the agitation now? In the past few years, the economy was going through the stabilisation phase and now the stability is achieved with multi-year low inflation and a build-up of foreign reserves to cover three months of imports. The only variable missing is growth.
The focus of economic managers is rightly on growth now and that is why the exchange rate is being kept artificially appreciated to bring down inflation and improve business sentiments. That is being done firstly by keeping the interest rate at the lowest level in 44 years. This will generate consumption-based demand with imports becoming cheaper and exports becoming expensive. If the domestic production is not able to enhance, the onus of additional consumption will simply fall on imports. This will worsen the current account deficit.
On the capital and financial external account, the improved sentiments have to attract FDI which are currently dried up. Otherwise, the debt repayments will start in FY17. If commodity prices reverse in 2018, another crisis will hit the economy and take the economic management back to stabilisation.
The government has this window of 18-24 months to translate this euphoria into actual growth. The monetary policy has done its job. The need is to work on energy provisioning, continued improved security situation and most importantly the China package has to start rolling.
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