Irrational exuberance

The SBPs decision shocked the economists, surprised the analysts, but was overwhelmingly welcomed by the business community. The idea is to whatever cushion the economy got on tamed inflation, is to build the private credit appetite. Although, the reasons cited on entrepreneurs shying away from investment are not primarily the higher interest rate but the structural woes. Energy shortages, law and order situation and inconsistent economic policies are paramount reasons for continued contraction in the both domestic and foreign investment. Nonetheless, big local groups are hunting for good assets whether it is Tabbas capturing ICI domestic operations, Dawood Group buying Hubco and Mansha bullying on AES Lalpir. The issue is not interest rates; its the dearth of good assets and viable opportunities that have not got the investors overly excited. The million dollar question is that would a 150 bps fall in interest rates entice the investor to start new ventures. Recent history suggests otherwise; private sector business credit remained at a mere Rs18.3 billion in FY12 when the policy rate came down from 14 percent to 12 percent with one 150 bps cut in Oct 11. On the contrary, private business credit was at Rs173 billion in FY11, when the interest rate hiked up in a staged manner from 12.5 percent to 14 percent. This depicts that there has been virtually no correlation of interest rates movement with investment of late. Monetary policy statement read that the economy has attained a new equilibrium of high inflation and low growth; though it hasn used the term stagflation but not far from it in narration. Balance of payment woes are goring on falling foreign flows, especially low FDI, which may not be helped by lowering the returns on domestic investment. Although, the Governor was optimist that the country has firm commitments on FDI in coming months from GCC countries; and he was also praising the currency swap arrangements with Turkey (to be operational in September) and China which is expected to work by the end of this calendar year, it may be too early to call the shot yet. The economists and analysts are not sure on the improvement in credit to private sector on lowering the interest rates which is exposing the fragile balance of payment recovery on receiving the CSF amount of 1.1 billion dollars and 31 months low inflation owing to fall in oil prices which have already started shooting up. But the major beneficiary of this step is the government of Pakistan whose cost of servicing the domestic debt is going to significantly fall on lowering the rates. It appears an Eid gift from the SBP to the Ministry of Finance on a good performance of retiring Rs198 billion of SBP borrowing in July. But the sustainability of this trend is highly susceptible, thanks to unresolved tax reforms and nothing on pending no tax revenues such as issuance of 3G licensing and many others. According to SBP fiscal deficit in FY12 is at 8.3 percent including food and energy sector circular debt conversion. And FY13 being an election years, the situation might only worsen. So watch out!