With the fiscal year FY11 coming to its close, the government has almost met all the major targets of IMF, against the expectations of critics. These include revised target of fiscal deficit, fiscal borrowing from the SBP and increasing efforts on the broadening of the tax base. To add to colours, full-year inflation remained marginally below the lower end of the range earlier projected by the State Bank.
These achievements open up the debate both internally at central bank and amongst the economics community as regards the easing of the monetary stance in the upcoming policy review due at the end of this month.
The FBR surprised all by surpassing the revised tax revenue target by Rs2 billion to close the year at a provisional number of Rs1590 billion on a net basis; while virtually all the seasoned economists, past policymakers and tax experts were of the view that FBR's collection might remain below Rs1530 billion.
The situation is not as pessimistic as what's popularly believed. The year-end fiscal deficit, excluding recent Rs120 billion (0.7 % of GDP) circular debt payments, stood at 5.3 percent - 0.2 percent lower than the revised target negotiated with the IMF after the floods.
On the deficit financing front, sources within the finance ministry revealed that fiscal borrowing from central bank for FY11 is marginally below the level at which the year started. Isn't it shocking?
Recall, when the SBP Governor in January kept the policy rate unchanged on the government's promise that it would keep the central bank's borrowing lower than the September-end level of Rs1290 billion, everyone took that as a promise of someone who is known as a sexually promiscuous person to his new girlfriend.
While flirting around that ceiling for while when the government effectively took it as a floor for five months, reportedly the fiscal managers have finally closed FY11's central bank borrowing below Rs1171 billion. This implies that the government has retired more than Rs150 billion of the high powered money in the last two day of the fiscal year, as SBP borrowing toll was at Rs1320 billion as of June 28.
It may not be of any surprise that the inflationary debt has been lowered further at the eleventh hour; since on June 30 alone, the FBR raised Rs50 billion in taxes, while the government raised Rs20 billion above the target in its last T-bill auction whereas foreign inflows to the tune of $450-500 million also poured in.
With June inflation at 13.1 percent, the FY11 CPI - averaging at 13.9 percent - calls for a review in monetary stance.
Global commodity prices are receding after touching their peak, and this may ease the cost-push supply side inflationary pressures. This is evident from the fact that food index (heavy weight in CPI) averaged at 16.26 percent in last three months versus 19.5 percent in the preceding six months.
International oil prices, on account of relative ease in the MENA unrest, are gradually falling as well - crude plummeted by 18 percent after peaking at $114/bbl in late April.
This along with political pressures may not force the government to increase electricity and gas tariffs as intended, which may have medium to long run repercussions, but surely help in easing inflationary pressures in short to medium term.
On the demand side, the devil is high powered money creation, and if the government is able to put reigns to it with the FBR meeting its target, inflationary expectations may fall in short to medium term.
The high base effect, a mathematical reality, is also going to help in improving the CPI numbers - and one may see inflation numbers in single digits in the second quarter before high base effect vanishes.
While on the balance-of-payment front, there is no immediate threat with well contained current account and the stagnant capital account. There is no reason for the SBP to not be dovish in upcoming policy review
Hence, SBP might lower its discount rate by 50-100 bps in July. However, the only caveat for further and aggressive easing is susceptibility in balance of payment.
The reverse cycle in global commodity prices may adversely affect exports and pick up in the credit demand after lowering interest rates might put strain on imports. This along with repayments of IMF from second half of this fiscal year amid elusive FDI may cause foreign reserves to fall like a pack of cards. More on this subject, later.
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