The National Credit Consultative Council (NCCC) meeting, chaired by the State Bank Governor on 4th July, reviewed as usual the monetary and credit developments during the past fiscal year and made projections for these aggregates for 2006-07.
The rate of monetary expansion that had averaged around 18 percent in the last four years came down to 13.33 percent towards the end of FY06. Full-year broad money growth in 2005-06 is, however, expected to be higher at 14.8 percent as compared with 19.3 percent in the previous year.
According to the Working Paper of the Credit Plan, "SBP continued to exercise tight monetary policy through frequent interventions in the interbank market to limit the supply of loan-able funds to contain inflation".
Monetary expansion during FY06 occurred primarily on account of build-up in NDA of the banking system which expanded by Rs 373.12 billion during July-10th June, 2006 because of more-than-targeted expansion in credit to both the government and non-government sectors.
Credit to the government amounted to Rs 131.86 billion as against the credit plan target of Rs 120 billion while credit to the non-government sector totalled Rs 335.12 billion as against the target of Rs 320 billion. The government's heavy reliance on bank credit came from the absence of borrowings from non-bank sources, additional demand for funds to finance earthquake related initiatives and commodity operations to ensure adequate supplies of essential inputs and food items.
A very significant observation in the Credit Plan is that "had privatisation and bond receipts not been realised, government borrowing for budgetary support would have been around Rs 235 billion as on 10th June, 2006".
As for 2006-07, the Credit Plan asserts that "tight monetary policy stance of the SBP is expected to continue through FY07". Broad money expansion has been projected at 13.5 percent.
"This projection is supportive of real GDP growth target of seven percent and inflation target of 6.5 percent". The projected monetary expansion is expected to emanate from accumulation in the NDA of the banking system due to the persistence of strong demand for private sector credit. NFA of the banking system is anticipated to rise moderately despite the expectation of a large trade deficit.
Though the State Bank seems to be, more or less, satisfied with its monetary policy stance, the monetary and credit developments during 2005-06 and projections for the current year are, in our view, a source of worry. The Credit Plan for FY06 had projected monetary expansion at 12.8 percent and this projection was made keeping in view the GDP growth target of seven percent and inflation target of eight percent.
Monetary expansion was deliberately kept below the nominal GDP growth of around 15 percent due to the monetary overhang that had stemmed from massive yearly monetary expansion since FY03, and its consequent fallout in terms of rising inflation.
The expected monetary expansion of 14.8 percent during 2005-06 shows that the State Bank failed to adhere to the target, and it should have targeted the growth in money supply even lower than the original targets but was also not able to absorb the huge monetary overhang of the previous years.
Clearly, this situation has serious implications for inflationary expectations in the economy and recent abatement in price pressures may only be temporary because underlying factors causing inflation have not been addressed. In fact, when there were indications that growth in real GDP during 2005-06 was going to be lower than the target, the State Bank should have targeted the growth in money supply even lower than the original target of 12.8 percent but nothing of the sort was attempted.
Some of the other developments were also not propitious. Government's inability to live within the projected limit of budgetary borrowings reflects a poor fiscal strategy. Its increasing reliance on the banking system is highly inflationary and could crowd out the private sector if the State Bank tries to adhere to the targets to contain inflation.
The profligacy of the government would have been obviously much more damaging in the absence of privatisation proceeds and receipts from foreign bonds. The government has to be fiscally more prudent and responsible to give monetary policy a chance to suppress inflationary tendencies in the economy.
A considerable part of private sector credit was used for consumer loans or non-investment purposes, which does not add to the productive capacity of the economy directly, has induced the general public to live beyond its means and may create recovery problems for the banks in future.
The State Bank needs to make a deliberate effort to redirect these financial resources of the economy to sectors like agriculture and SMEs. In its working paper, the State Bank has advanced many arguments for the accelerated growth of these sectors. It was, however, sad to note that the rate of credit growth to these two sectors slowed down during 2005-06.
The projected rate of monetary expansion for 2006-07 would mean a higher increase of about Rs 460 billion in money supply. This, on the back of previous monetary overhang, could exacerbate inflationary pressures in the economy. The State Bank believes that this projection is supportive of real GDP growth target of seven percent and inflation target of 6.5 percent.
Such an approach, we believe, is basically flawed because it obliges the State Bank to project a higher monetary expansion if inflation is targeted on the higher side and, therefore, in a way, is tantamount to financing the vicious circle of inflation by monetary authorities.
In the absence of legal powers to deny government's request for money from the central bank, we would urge the State Bank to itself fix a reasonable level of inflation and then maintain strict monetary discipline to achieve that target. This may require much lower injection of liquidity than stipulated in the Credit Plan. In the world today, performance of central banks is judged by the degree of price stability in the economy and not by its role as a growth agent. In fact, these two objectives are not mutually exclusive.
The State Bank may have projected a growth rate of 13.5 percent in money supply, believing that inflation is on a downward path, but there is no evidence to suggest that such a trend will be maintained. Also, the current rate of inflation is too high to be tolerable for a vast majority of the people in Pakistan and needs to be brought down further.
Some of the decisions made in the NCCC meeting were overdue. The proposal to rename NCCC as "Private Sector Advisory Council (PSAC) is in keeping with the new role of this body. The agreement to set up an Infrastructure Task Force to help improve the financing to meet the growing requirements of the economy is timely and it was good to remind the Pakistan Banks Association to bring down the spread between lending and deposit rates for the benefit of small depositors. Moral suasion is, however, not expected to work.
It will take a long time for profit/interest on deposits to move above the inflation rate and give a positive return to depositors. SBP needs to fix a minimum rate on savings accounts or else persuade the National Bank of Pakistan to hike the returns to its account holders. Until this is done, expecting the big five network banks to voluntarily do the SBP's bidding is an unrealistic expectation.
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