The State Bank of Pakistan (SBP) issued "Monetary Policy Statement for July-December,2007"-(MPS)- on 31 July,2007. The peculiar feature is a basic change that has been introduced in the Export Finance Scheme (EFS) under which short term pre and post shipment finance is provided to the exporters at the concessional rate of 7.5 per cent p.a.
The funds are provided to lending banks by the SBP at a lesser than the bank's lending by 1 per cent p.a. The revised scheme envisaged in the MPS provides that the SBP will, henceforward, provide 70 per cent of the funds lent out by the banks to the exporters.
The MPS says that the objective is to gradually reduce the reliance of the commercial banks on SBP for export refinance facility and encourage the banks to mobilise the desired resources to fully accommodate private sector, including export related finances.
In addition to the short term export finance, SBP has also been providing funds for long term lending to the export-oriented industries at the concessional rate of 4-5 per cent p.a.for procurement of machinery (LTF-EOP). In fact, during the fiscal SBP had allowed swap of such high priced long term loans with the low priced ones.
As per the figures given in Table 4 of the MPS, total facility availed of under both these schemes during Fiscal FY-07 aggregate Rs 61.5 billion [Rs 26.6 billion EFS+ 34.9 billion LTF-EOP] which will be 1/4th of the banks' overall lending to private sector.
The swapping of LTF-OEP high priced loans [which were earlier provided by the banks from their own resources] with the low priced ones may be one of the reasons for higher figure in FY-07. It may come down in the coming days. This is also inferred from para 15 of the MPS which asserts that the concessional LTF-OEP financing did not yield new investments.
One can, therefore, safely assume that it is not a question of shortfall of resources in the banking industry which has been coercing the SBP to supplement but it is basically the question of provision of subsidy in the interest rates to the concerned borrowers.
Obviously, it was the banking industry's reluctance to provide loans at lower than the market rate which coerced the SBP to intervene- of course- as per the government's policy. However, the scheme proved beneficial to both - the SBP as well as the government as SBP is adding to its profits enormously simply by creating money while the government is the ultimate beneficiary as the SBP profits are transferable to the government.
Under the revised scheme, 30 per cent funds under EFS shall be provided by the banks from their own resources; but at the concessional interest rate of 7.5 per cent p.a. The MPS states that the amount of the export finance provided by the banks from their own resources would be eligible for deduction from their demand liabilities for the purpose of determining the CRR[Cash Reserve Requirement]. At present, the banks are required to place with SBP interest-free 7 per cent of their demand liabilities as CRR.
Hypothetically, taking the FY-07 export finance figure of Rs 26.6 billion, the banking industry will be required to provide finance to the extent of Rs 7.98 billion from their resources while Rs 0.55 billion will be released from the CRR which will additionally be available for lending at the market rate.
This will reduce the impact of the EFS lending to merely Rs 7.43 billion which is not very insignificant portion of overall lending of the banks. The scheme, although designed to contain the monetary expansion, is unlikely to have any significant impact in that direction in the short term while resistance from the banking sector is likely if the entire onus is placed on it by the SBP gradually.
The MPS hints about the misuse of the funds borrowed under the EFS. It was prevalent in the past and will continue in future also as there is hardly anything that can tangibly be done by the SBP or the banks to stop the misuse.
Other important features of the MPs are:
(a) Zero-rating of CRR for all deposits of one year and above maturity;
(b) Raising of SBP discount rate from 9.5 per cent to 10 per cent;
(c) Introduction of Long Term Financing Facility (LTFF) to promote industrial-led growth. The finance under the scheme will also be provided by the SBP/banks in the ratio of 70:30.
(d) The banks have been charging monthly penalties from the account holders where the balance in the account fell below the minimum balance requirement (MBR). The size of the MBR and monthly penalties differed from bank to bank. The maximum monthly penalty limit has now been fixed by the SBP at Rs 50.
As for (a), the benefit can be universal only when the banks are prepared to give better returns to the depositors; otherwise the sole beneficiaries will the banks. (b) The increase in the discount rate will hardly impact the lending rate (and consequently the credit expansion) in any significant way as we have witnessed in the past that the banks' lending rates were not sensitive to the SBP discount rate.
In pre-July,2005 era, when the lax monetary policy was in vogue, the lending rates had fallen to the lowest level of 4-5 per cent p.a. while the SBP discount rate did not come down below 9 per cent. (c) The LTFF would also envisage absorption of interest rate subsidy [if the intention is to keep the lending rate lower than the market rate] by the banks on their portion of funding. Let us see whether the banks will digest it or put up resistance. (d) There is hardly any justification in keeping MBR or the monthly penalty in force. SBP should waive these requirements altogether.
INFLATION: SBP had commenced tightening the monetary policy in July,2005 with a view to decelerating the inflation but no success seems visible. The CPI inflation in FY-06 was 7.9 per cent which stands at 7.8 per cent by the close of FY-07.
The main cause of worry is the food inflation which was 6.9 per cent in FY-06 and reached 10.3 per cent in FY-07. The MPS asserts that had the food inflation stood at FY-06 level (6.9 per cent) in FY-07, the CPI target of 6.5 per cent could be achieved.
It is believed that in the market economy, the higher availability of the goods reduce the prices. This theory is not working in Pakistan because despite bumper wheat crop, the prices are on the rampant increase.
Our economic managers believe that higher economic growth is also responsible for the fuelling of inflation. In our case, the inflation is higher than the real GDP growth rate but in India and China [and particularly in China], the inflation rate is much lower than the GDP growth rate. How these countries could achieve lower inflation with higher economic growth?
EXTERNAL COMMERCIAL BORROWINGS [ECB]: The MPS states that "consistent with the growing trend in the corporate sector of Pakistan to access to the international markets for funding requirements, SBP is issuing instructions to further liberalise and rationalise the ECB".
The question is: why is the corporate sector leaning towards borrowings from abroad instead of domestic sources? The MPS does not analyse this important aspect but the authorities seem to be engaged in framing policies encouraging borrowings from overseas.
The reason may be the increasing interest rates in the domestic market on account of pursuance of tight monetary policy since July,2005 which has made the external borrowings cheaper for the corporate sector.
This also raises the question whether will it be advisable to shift the banking business from domestic to foreign market by letting the lending rates increase domestically, particularly when the tightened monetary policy has not helped in lowering the head-on inflation [CPI].
The economic managers seem content with the deceleration in the core inflation while over 3/4th of the populace is severely hit by the food inflation. The shifting of banking business from domestic market to the overseas market naturally does not seem desirable in the long run.
GOVERNMENT BORROWING FROM SBP: In the fiscals, FY-05 and FY-06, SBP had provide finance to the government not only to meet the fiscal deficit but to also retire the borrowings from the commercial banks.
These fundings were obviously very inflationary. FY-07, however, presents a welcome change as the entire budgetary support borrowings [Rs 160.6 billion] came from the commercial banks while SBP debt was retired to the extent of Rs 58.6 billion. The retirement of SBP debt may have, however, been possible due to accrual of funds from privatisation proceeds/OGDC GDRs etc.
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