Traditionally, stabilising prices and striving for fuller employment were the accepted objectives of the monetary policy. It took economists a while to realize that unless fiscal policy objectives are aligned with monetary policy objectives, economic stability remains a mirage. The saner aspect of the January 29 version of SBP's monetary policy was the belated acceptance of this reality.
In the long run, monetary policy exercises little influence over production, inflation and employment, especially in un-documented and overly un-regulated economies; population growth, technological advances and market regulation are the factors that fuel or blunt long-term growth. In isolation, monetary policy can't deliver because fiscal policy determines the path for current and future deficits and, consequently, stability and growth.
That's why the SBP Governor kept referring to political consensus on economic re-structuring because textbook approach to containing inflation via fiddling with the discount rate doesn't work; if markets remain un-regulated risks skyrocket, and risk-aversion forces banks to push SMEs into borrowing from money lenders - a scenario portraying the grossly ill-governed Pakistan. SBP has, therefore, pushed the ball into the politicians' court.
The 'gracious' SBP decision not to jack up the discount rate yet again, has more to do with limiting the chaos expected after the coming massive oil price hike effective February 1. As for the odd external account surplus, the factors increasing remittances in the worst global recession since World War-II need looking into; do they include 'round tripping' of the money disappearing from state offices? A stable rupee could help round tripping.
The worrying part of the monetary policy, however, is that while the state will reduce its borrowing from SBP to its September 2010 level, ie repay a nearly Rs 200bn, it will start borrowing from commercial banks given the fact that its spending spree hasn't slowed down. With the much touted economic re-structuring at a standstill, more of bank credit will be consumed by the state.
Recently, credit-rating agencies had down-graded the ranking of Pakistan's big five banks due to their excessive investment in sovereign debt. Reason: since lending rates applied to sovereign debt included premiums as high as 3 percent the sovereign is no longer perceived as the traditional zero-risk entity. Given this backdrop, will banks lend more to the state, or will the state become insolvent?
Already, we hear about state employees not being paid (eg lady health workers) and others planning to stop working if their salaries aren't jacked-up to help them coup with skyrocketing inflation. This foretells the future - scenarios resembling those being witnessed in Tunisia, Egypt, Jordan and Yemen. Should that happen, SBP won't be at fault; the state will carry the blame - the benefit of pushing the ball into the politicians' court.
The parliament was informed about the totality and profile of sovereign debt as on November 30, 2010. The figures were baffling: domestic debt stood at Rs 5.13 trillion and external debt at $53.654 billion together adding up to 64 percent of the GDP exceeding the limit imposed by the Debt Limitation Act. If unfounded debt too was included, the total debt amounted to over 74 percent of the GDP.
Besides pervasive corruption, subsidies to Wapda and Pepco and blocking of funds in food stocks largely accounted for the fiscal deficit. Subsidy to Wapda and Pepco amounted to Rs 113.6bn in 2007-08, Rs 90.4bn in 2008-09, Rs 146.5bn in 2009-10, and in 2010-11, it would be Rs 130bn for Pepco, Rs 40bn for circular debt and Rs 38bn for payment of bills in Fata, provided the oil price stays around $90 a barrel.
Signs are that oil price could touch $120 a barrel in 2011. Wilder estimates predict tripling of oil price in the next ten years if countries don't switch partly to alternate energy sources. This scenario doesn't include the 1982-like crisis (that I watched from the UAE) during Israeli invasion of Palestinian camps in Sabra and Shatila when it seemed that the Suez Canal may be closed and, along with it, Middle Eastern oils supplies to Europe.
Talking of alternate energy development, two recent disclosures are shocking. First, alleged fraud of Rs 6 billion in Pakistan's Alternate Energy Development Board (AEDB) and, second, US government decision to walkout of a commitment to invest $350 million in a power generation project based on wind energy. That's a two-way hit courtesy the head of AEDB who, reportedly, belongs to Larkana.
As for tax collection by FBR (cited as another reason why SBP did not jack-up the discount rate), a baffling shocker surfaced a day later. The media reported that Accountant General of Pakistan found that the 'reported' revenue exceeded the amount actually collected. Let us hope that eventually it turns out to be a reconciliation error, but if it doesn't, revenue collection will become suspect and the real fiscal deficit will expand.
Given this uncertainty, is it realistic for SBP to assume that the state would repay its debt, and ask the banking sector to finance it? The big negative of shifting the sovereign debt to the banking sector would be even less availability of credit to the private sector, especially SMEs - backbone of any economy, more so Pakistan's - and that too in a scenario of rising NPLs largely due to risks crystallized by bad governance of the state.
Banks are averse to lending to the SMEs because they can't provide the sort of collaterals banks require to counter the rising variety of risks; loan pricing is not as big an issue. With reduced ability to lend, banks would be even more unwilling to lend to SMEs, thereby forcing them to borrow from 'money lenders' at exorbitant rates of mark-up. Surely, this cost will be added to the price of the goods and services they sell.
Will this shift bring down inflation, is a million-dollar question. Visibly, the philosophy we now subscribe to is "everyone for himself and God for us all." This philosophy is the worst any sane entity could imbibe, least of all state institutions. The solution lies in changing the existing order to hasten the recovery of squandering state funds; making up for this loss by any other route, especially passing the buck, is both impractical and unethical.
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