MONEY WEEK: monetary expansion remains subdued amid continued drawdown of foreign reserves

When net foreign assets (NFA) of the banking system- or crudely put the country''s liquid foreign exchange reserves- accumulate, money supply increases even if government borrowing or private sector credit utilisation remain unchanged at their existing levels.
Money supply contracts or monetary expansion decelerates when foreign assets are depleting depending upon whether domestic credit expansion (DCE) remained unchanged (contraction case) or expanded instead (deceleration case). The latter was the case on 2nd and 9th September according to the latest updates of monetary statistics of the country. On 2nd September, domestic credit expanded by Rs60 billion but monetary expansion was limited to Rs7 billion only.
On 9th September, DCE amounted to Rs95 billion but monetary expansion was even less than half (Rs43 billion) the size of DCE. Each time, the explanation for subdued monetary expansion was the massive drawdown of NFA on these dates, which roughly averaged to Rs52 billion on each occasion. In our last review, we extensively dealt with BOP factors leading to accumulation or drawdown of foreign reserves.
In the meanwhile, as a result the foregoing changes in monetary statistics, liquid reserves of the country declined to $12,569.6 million on 2nd September though the same improved nominally to $12,570.1 million on 9th September compared with $12,652.7 million at the end of August, $12,854.2 million at the end of July and $13,136.9 million at the end of June 2006.
The reserves improved for a short while to reach $12,602.1 million on 16th September but according to latest updates, beginning 23rd September, the downslide in foreign exchange reserves set in again with reserves standing at $12,546.6 million as on that date and stood further lower at $12,532.9 million on 30th September.
It appears the drawdown has continued except on one weekend as explained above during September. The cumulative loss of reserves for the period July 01- September 30 comes to about $604 million meaning that still larger increase in imports and drawdown of NFA of the banking system has occurred after 9th September which will largely offset the impact of borrowing from the banking system by the government and the private sector in the coming weeks.
Among other developments, government borrowing which decelerated to Rs47.5 billion on 26th August, after having reached Rs64.8 billion on 12th August, picked once again to reach Rs72 billion on 2nd September and further to over Rs97 billion on 9th September- the date for which the latest update is available. On 9th September, Rs89.7 billion were borrowed for budgetary support and Rs6.2 billion for commodity operations compared with Rs64.4 billion and Rs6.5 billion respectively on 2nd September.
Break-up of budgetary borrowings revealed that on 9th September, Rs73 billion were borrowed by the federal government and Rs16.7 billion by the provincial governments compared with Rs58 billion and Rs6.4 billion respectively on 2nd September. Both federal and provincial governments borrowed exclusively from the central bank (plus Rs96 billion compared with end June position) as they retired credit to the scheduled banks (minus Rs6.8 billion compared with end June position) on 9th September compared with plus Rs64 billion borrowed from the central bank and minus Rs6.7 billion retired to the scheduled banks on 2nd September.
Private sector, which showed a retirement of Rs11 billion on 26th August continued showing retirement of credit even on 2nd and 9th September but the magnitude of retirement declined on 2nd September (minus Rs7.35 billion) but increased on 9th September (minus Rs11.43 billion). The development showed that the impact of fresh borrowing of Rs3.7 billion that took place on 2nd September was more than offset by the increase in retirement of Rs4.1 billion on 9th September.
Larger retirement on 9th September took place on account of commercial banks (minus Rs17.6 billion compared with end June position) as specialised banks, which include the SME Bank, showed net credit expansion of Rs6.2 billion as on that date as against a retirement of Rs12.1 billion by commercial banks and an expansion of Rs4.7 billion by specialised banks on 2nd September. As part of non-government sector credit expansion, credit by the banking system to PSEs shrank by Rs3.5 billion compared with a smaller retirement of Rs2.9 billion on 2nd September whereas SBP credit to NBFIs increased by a nominal Rs0.2 billion on 2nd September which remained unchanged at that level on 9th September.
Behaviour of other items (net) or OINs of the banking system, a segment of domestic credit expansion or contraction, changed significantly. These items, which exerted a contraction impact of Rs4 billion on 26th August compared with a much larger contraction impact of Rs57 billion on 15th July, started exerting expansion impact as from 9th September as compared with a very small contraction impact of Rs1.3 billion on 2nd September. Between 2nd September and 9th September, expansion in domestic credit on account OINs amounted to Rs13.3 billion.
Overall, domestic credit showed an expansion of Rs95 billion on 9th September compared with Rs60 billion on 2nd September. Money supply figures for the respective dates showed a smaller expansion of Rs43 billion and Rs7 billion which found expression in the drawdown of NFA to the tune of about Rs52 billion on each date.
A 7th October update released late on that day showed that on 16th September, monetary expansion decelerated to Rs29 billion but mainly on account of decline in government borrowing to Rs67.6 billion (budget: Rs61.4, commodities: Rs5 billion, other: Rs1.2 billion) as both private sector credit expansion and NFA improved.
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