MPS: expect nothing!

Government borrowing from the central bank was below zero for the outgoing year; the current account showed a surplus, the NFA to NDA ratio improved, inflation was within its annual target and was much lower in the second half of the fiscal. So do these conditions warrant an ease in the policy rate tomorrow?
Well its a tricky question. A decade back in Turkey, just a few months before the country witnessed a deep economic crisis, key macroeconomic indicators had been as sound as they appear in Pakistan today. But soon the countrys economy had been plunged into runaway inflation.
The devil in the room is the fiscal deficit and according to a school of thought which is close to the central banks monetary policy team; this deficit is the chief reason for inflation, regardless of its financing pattern. Although the official numbers are not yet announced, the fiscal deficit for FY11 is likely to be in the proximity of six percent of GDP, compared to last years fiscal deficit which stood at 6.3 percent of GDP.
Persistently high fiscal deficits have so far kept the central bank from adopting a dovish monetary stance. And lately, the tussle between the finance ministry aboos and SBP is telling tales about the as-yet unpublished deficit numbers. Simply put, while the baboos are chasing records, the latter is calling a spade, a spade. Reportedly, this clash was the tipping point that drove Kardar from the office of the SBP Governor.
FBR conceded that its earlier claim of having achieved the revenue target was wrong. Having missed the revenue target by 0.2 percent of GDP, serious doubts have been cast on the governments claims of restricting the fiscal deficit to 5.3 percent of GDP; excluding Rs120 billion (0.6% of GDP) for circular debt payments. The detailed MPS will be released with the policy rate decision and this may give more clues about the final tally.
The IMF is probably not pleased with these developments and talks with the fund that were to be held during July, have been delayed. At this point, both the acting governor SBP and those at the helm of the finance ministry are scratching their heads to find a way to convince the fund to remain in the existing programme.
But the odds are stacked against this proposition and any new program with the IMF would be more like the stringent deal offered to the country back in the 1990s. Speaking on a light note, a senior economist recently commented that any new IMF programme will come with a flurry of conditions including having to report the morning bathroom rituals of the countrys finance minister, Hafeez Sheikh.
As a proponent of a tight monetary stance, the IMF will certainly not be pleased by any reduction in the discount rate, tomorrow. And running a relatively higher fiscal deficit places the government under the hammer.
Globally, the impact of continued quantitative easing in the US is overheating assets across the globe. India and China have recently increased their key policy rates and many economies are expected to follow suit. It is indeed, hard for us to move against the global trends.
Digging more into numbers exposes the fragility of the improvement in macroeconomic indicators. Although the government has significantly reduced central bank borrowing; it has shifted its debts to the commercial banks which lent Rs598 billion (3.3% of GDP) in FY11 versus Rs286 billion (1.9%) in the previous year to finance the fiscal deficit. Higher growth in money supply (15.9%: FY11 versus 12.5%; FY10) owed to the BoP surplus, thanks to high prices of exported commodity and growing remittances.
The NFA to NDA ratio improved as well, which is highly correlated to inflation- the higher the NFA to NDA ratio; the lower the inflation. But is it sustainable?
Cotton prices are falling sharply, oil prices are high and more importantly strains in Pak-US relations are casting doubts on the continuation of foreign flows in the form of aid and loans. There are some signs of imminent currency depreciation, as well.
Food inflation is also on the rise again. The sensitive price index has been rising for the last eight weeks. The house rent index in the CPI has bottomed out and is likely to go up this year. Ramazan will also likely come with the usual surge of food prices.
Last but not the least, the prime reason for the economic slowdown is supply-side disruption due to severe energy shortages and there appears to be no quick fix to this debacle. So a relatively dovish policy stance may not necessarily translate into higher demand for credit by the private sector which is being choked by power shortages.
Having literally lost its head (honcho) for the third time in two years, the central bank may well keep its moves in check and maintain the status quo on its policy rate.