The State Bank of Pakistan (SBP), at long last, seems to have woken up to the reality of rising prices. In its report for the first quarter of FY05, released on 29th December, the emphasis has clearly tilted towards the need of containing price pressures rather than maintaining an easy monetary stance to spur growth momentum. The likely shift in policy has been justified on several grounds.
THE MAIN ARGUMENT IS: "While the potential structural shifts can indeed be an important factor in the SBP's short-term monetary posture, the central bank has also to keep in view the inflation trends in the country". Although the acceleration in inflation may be tapering off, the CPI inflation remains pegged stubbornly around 9 percent (against the annual target of 5 percent) and core inflation is still climbing.
Inflation pressures, according to SBP, "would have been boosted by the recent increase in domestic oil prices, and the risk could rise further if water shortages result in lower supply of agri-produce."
The report also points out that attempts to maintain low interest rates for an extended period in the face of high inflation would be counter-productive. Besides, "it should also be kept in mind that the average real lending rates are already negative, and their continuation would encourage non-productive borrowing and speculative activities".
Whether the balance of risks justifies a further tightening of monetary stance is, however, likely to be determined in the light of December 2004 data.
SBP also seems to recognise that modest tightening of monetary policy in the recent months has not yielded the desired result.
A 161 basis point rise in 6-month T-bill yields through July-November, 2004 has not made an appreciable dent in the demand for credit to the private sector which has risen by Rs 163 billion as against Rs 125 in the same period last year.
However, despite exceptional rise in private sector credit and 111 percent rise in budgetary borrowings of the government, M2 growth was in line with the annual plan target due to slow growth in NFA, contractionary impact of other items and reduced PSE borrowings.
Since a part of the former may represent a transitory impact, M2 growth may accelerate in the months ahead. Due to a number of factors, including monetary overhang from the previous years, the State Bank expects the CPI inflation in the range of 7.6 percent to 8.2 percent, well above the 5 percent target for FY05.
This rather optimistic forecast is based on the assumption that large and timely wheat import would contain its price and domestic oil prices will decline in the coming months in line with an anticipated weakening of international oil prices.
The State Bank expects a mixed performance in other important areas of the economy.
Its forecasts indicate that GDP growth is likely to be in the range of 6.5 percent to 7.1 percent during FY05 or close to the target of 6.6 percent but somewhat higher than 6.4 percent actually realised during FY04. The downside risks to the economy in the current year, nonetheless, stem from higher inflationary expectations and a worsening trade balance. A sharp increase in the import bill, reflecting high prices of oil and rising imports of machinery and raw materials, is projected to widen the trade deficit, leading to a modest current account deficit.
Ironically, the exceptional growth in imports is likely to help the fiscal position of the country, though a strong increase in current expenditures remains a matter of concern. Looking ahead, the sustainability of high growth can only be ensured if Pakistan is able to take advantage of the opportunities offered by the end of ATC regime in January 2005.
While the domestic industry has to invest heavily to this end, the government must extend a helping hand by providing a conducive legal and regulatory environment, supportive infrastructure and logistic management as well as heavy investments in training and skill up-gradation of the labour force.
"In the shorter-term, there is also an opportunity for Pakistan to reduce the costs of business by reducing red-tape, improving governance and ensuring policy continuity."
The contents of the report, in our view, reflect accurately the present position of the economy and the projections for the whole year are based on a careful analysis of the situation likely to obtain in the remaining part of the year.
The confirmation from the State Bank that real GDP growth is going to be near the target fixed for FY05 is a good news. It is also heartening to note that GDP has consistently increased since 2001-02 and the rate of increase is now well above the population growth rate which is an indicator that per capita income is rising continuously and if appropriate policies are followed, the standard of life of the ordinary people in the country could be gradually improved. In a declining economy, such a scenario was not possible.
On the other hand, the State Bank has not failed to point out the emerging weaknesses in the form of higher inflation and current account deficit and also proposed appropriate measures to arrest this trend, wherever possible. Sharp growth in current expenditures is also a negative factor.
Another factor impacting the fiscal scene negatively could be the delay in the privatisation of certain PSEs like KESC. We would urge the relevant authorities to take note of these adverse developments in order to initiate timely action. The State Bank has also repeated the usual advice of training and skill up-gradation, improving governance, ensuring policy continuity etc.
Though nobody would disagree with the usefulness of such measures, in our country statements of this kind have become cliches, meant to be preached but difficult to put into practice.
Some concrete and practicable advice on these matters would surely have been more helpful. Besides, the quality of import data needs to be improved considerably. It is surprising that oil imports vary significantly from historical trends when there is no significant shift in the structure of the economy.
The most distinctive and encouraging feature of the report this time is undoubtedly the growing concern of the State Bank about inflationary tendencies in the economy and clear indications about tightening of monetary policy after assessing developments in the light of December 2004 data. This is obviously a departure from its earlier policy to maintain low interest rate environment to spur growth.
In our view, this is a very welcome change in strategy for which we have been arguing for the last several months. The report has discussed the issue in considerable detail and defended the likely shift in policy on several grounds. We may, however, like to add that inflation is another form of regressive taxation, which increases the miseries of deprived sections of the society and there would be hardly any country in the world where average lending rates are negative in real terms.
In fact, capital-deficient countries like Pakistan always try to give positive rate of returns to the depositors in order to increase the saving rate in the economy.
Besides, a higher rate of return would also increase deposit mobilisation which, as pointed out by the State Bank, has lately slowed down. Also, to put further pressure on the poor people in Pakistan where they constitute one third of the population and are already living from hand to mouth would be quite inhuman.
We would, therefore, urge the State Bank to immediately give a practical shape to its changed stance which has been forcefully advocated in the report and preferably aim to contain the inflation rate below 5 percent by tightening the monetary policy appropriately.
This is possible because after the autonomy act, our central bank now has all the tools at its command to fulfil its responsibility of maintaining price stability in the country.
As a supplementary measure, the government should make concerted efforts to correctly estimate the size of wheat crop and replenish the existing stocks of the commodity to comfortable levels by importing enough quantity to meet the shortfall.
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