The external accounts have managed to show surplus in the past two months (Sep-Oct) on the basis of lower imports owing to slowdown of economy, as one-fifth of the country was not fully functional due to floods, while sharp surge in cotton prices - raw material for main export items - supported the country's overseas sales.
But the surplus was also because of the one-time donors' money that poured into the country to meet the immediate needs of the flood affectees. Nonetheless, the persistence fiscal imbalance and the reliance of its funding on domestic banking sources, mainly the central bank, supply side shocks on food items due to floods and northward journey of global commodity prices, due to second round of quantitative easing in the west, allowed the inflation dragon to ravage the economy.
This not only offset the improvement in external account but, if regional tightening and the gradual recovery of the dollar failed to arrest the acceleration in global commodity prices, the threats of inflation spiral might shift the votes of monetary policy committee in favour of further tightening.
Last two months' inflation numbers - even after a second consecutive tightening of 50 bps - are over 15 percent, which takes the real interest rates marginally in the negative territory. Under such circumstances, domestic money can divert to commodities rather than in banking and saving instruments. This can result in hoarding practices in basic food commodities like sugar and wheat - a situation similar to what happened in 2008 when interests were negative for a few months.
Higher food inflation, with consequent price hike in other items is an undesired outcome of such practices. To curb it, along with already built inflationary pressure, the handy tool for MPC is to raise the borrowing cost by a further hike in policy rate.
Government revenues and expenditure gap is increasing amid the mounting pressure from foreign donors--be they loaner countries or multilateral agencies--to put the fiscal house in order. The long-term solutions are far from being implemented, no thanks to lack of political economic will. However, some short-term solutions are likely to be implemented soon.
With the persistent pressure of IMF, by holding back the last two tranches of standby programme, the RGST is slowly but surely passing through political process. Despite being strongly opposed by opposition parties and coalition partners, the bill has been passed by the Senate. Nothing can be said with certainty unless it is passed by National Assembly. But, if the RGST gets implemented, it may create an inflationary spiral by passing on the prices to consumers.
Similarly, the pressure from the World Bank and the ADB, along with the IMF, is pushing power tariffs up, to plug in the gap between cost and revenues of a few power producing companies, currently being borne by the federal government in the form of subsidy.
The efficacy of raising power tariffs in isolation to curtail the thefts and improve the power mix as well as overhauling of some inefficient government-owned power producing units may not be able to kill the devil of circular debt that is plaguing the economy. But higher tariffs will raise the cost of doing business and will slowly pass on to the consumers, hence inflation.
Although there are some signs of revival in private credit owing to seasonal working capital demand and boost in agri and textile manufacturing economy due to hike in commodity prices, hike in interest rates and government's appetite towards scheduled bank financing for its revenue shortfalls is going to continue private credit crowding out. But the SBP appears helpless to rescue it; hence a 50 bps increase in the discount rate should be expected today.
MONEY AGGREGATES
The rise in cash cattle economy took Rs 54 billion out of the system even two weeks before the Eid. This pattern may continue for the next two weeks--another Rs 50-60 billion increase in the currency-in-circulation is on the cards. But this money will slowly come back to the system, as witnessed in previous years.
Despite sharp increase in CIC demand and time liabilities marginally fell as government borrowed heftily from the central bank. Overall, money supply increased by 0.85 percent or Rs 49 billion for the week ending November 5.
There is not much to talk about net foreign assets, which increased by just Rs 5 billion to make the year to date toll at Rs 56 billion, while the government was busy in financing its needs from banking system. High powered money creation was Rs 43 billion while government raised Rs 24 billion from the scheduled banks. (Feedback at [email protected])
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KEY MONETARY AGGREGATES AS ON NOV 5
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Rs (mn)
5-Nov 29-Oct Change
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Currency in Circulation 195,015 140,915 54,100
Total Demand & Time Deposits (37,970) (33,111) (4,859)
Broad Money (M2) 158,472 109,230 49,242
NFA 56,124 51,146 4,978
NDA 102,347 58,084 44,263
Net Government Borrowing 235,821 168,859 66,962
Borrowing for budgetary support 258,595 191,558 67,037
from SBP 182,238 139,208 43,030
from scheduled banks 76,357 52,350 24,007
Commodity operation (24,189) (24,118) (71)
Credit to non-govt sector (20,035) (22,667) 2,632
to private sector 411 2,834 (2,423)
to PSEs (20,899) (25,955) 5,056
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Source: SBP
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