As widely anticipated, the Central Board of Directors of the State Bank has again decided to keep the policy rate unchanged at 12 percent for the next two months. However, while justifying such a stance, the Monetary Policy Statement (MPS) this time has focused, much more than usual, on highlighting "its part in balancing the implications of multiple challenges faced by the economy", particularly the limited set of instruments at the State Bank's disposal to tackle these challenges.
Even a cursory look at the MPS is enough to indicate that the SBP is highly disturbed about the growing fiscal deficit, excessive budgetary borrowings from the banks and the adverse impact of this fiscal mismanagement on prices and balance of payments. Government borrowings for budgetary support during July-March, 2012 were Rs 373 billion from the scheduled banks and Rs 218 billion from the SBP, which were higher by 56.5 percent and 18.5 percent respectively on a yearly basis, while private sector credit grew by only 4.2 percent. This means that "banks continue to prefer financing the fiscal deficit as opposed to searching avenues, taking risk and building partnerships to facilitate credit to the private sector".
The cost to the economy of such lopsided policies was apparent in terms of a decline in investment to the GDP ratio to historically low levels and stagnant economic growth that was considerably lower than the economy's potential. The State Bank, which earned criticism from the International Monetary Fund (IMF) for becoming "too accommodative" in relation to its dealings with the federal government, was also blunt in reminding the government that its borrowings from the central bank were required to be repaid at the end of each quarter under the State Bank of Pakistan (Amendment) Act, 2012. Injection of substantial liquidity in the system to keep the payment system functioning and the financial markets stable carried inflationary risks. The State Bank this time has also showed its concern about the rigidity of deposit rates and its adverse impact on the saving-investment ratio of the economy. It was argued that a more balanced risk-reward incentive structure was warranted in the shape of an appropriate deposit rate structure, as the savers, specifically the smaller ones, needed to be adequately compensated. As such, it was decided, that effective May 1, 2012, all the banks would be required to pay a minimum profit rate of 6.0 percent on PKR Saving/PLS Saving Products.
We feel that the State Bank's assessment of the current state of the economy, particularly inflationary expectations, is a timely reminder of the tough challenges lying ahead and the potential of high costs/risks involved. By not raising the policy rate, SBP has itself taken a risk. The SBP had slashed the policy rate by 1.5 percentage points to 12.0 percent in October, 2011 in the hope that the government would be able to achieve the annual target of GDP growth rate of 4.2 percent and contain the fiscal and current account deficits to 4.7 percent and 0.6 percent of GDP respectively which would pave the way for moderation in inflation and further reduction in the policy rate. Unfortunately, contrary to expectations, all major indicators of the economy have shown distinctly deteriorating trends since then and left no choice for the State Bank to inject liquidity on a permanent basis to keep the payment system going. Pre-emption of the country's resources by the government at a large scale through the banking channels was leaving little space for the private sector to borrow from the banks. The irony was that the commercial banks themselves were feeling comfortable with the present arrangement because it allowed them to invest in high yielding, risk-free government securities and earn high profits without much effort. However, for the economy as a whole, it was an unfortunate situation. A very low investment rate forced by higher government borrowings, resulting in stagnant growth and lower availabilities in the economy and extremely lax fiscal policy, stimulating demand pressures and fuelling inflation was a kind of nightmare for the monetary authorities.
Businessmen who are clamouring for a reduction in the policy rate need to realise the difficulties of the State Bank, which has to wait for a substantial reduction in government borrowings from the banking system and visible signs of softening of price pressures before taking such a step. The monetary authority of the country, of course, has the mandate to ask the government to repay the incremental borrowings from the State Bank at the end of each quarter as provided under the amended Act 2012, but whether the country can afford another confrontation between the two institutions is a matter worthy of serious consideration. Anyhow, if the government is forced to abide strictly by the Act, it would be required to submit a statement to the parliament with justification, with the result that the State Bank would ultimately not be able to force the issue and has to be content with an unfavourable status quo, exposing its limitations further.
We have been urging upon the State Bank for a long time to persuade the scheduled banks to offer a higher rate of return to the depositors and narrow the spreads between the deposit and advance rates to a reasonable level. This was necessary to expand the deposit base, tilt the risk-reward incentive structure in favour of small savers and make the economy self-reliant through higher domestic investment.
The increase in the minimum profit rate on Saving and PLS Products from five percent to six percent as mandated by the State Bank with effect from 1st May, 2012 is definitely a step in the right direction. A more effective analysis of the monetary data clearly shows that banks can ease by paying at least seven percent profit on savings deposit as they earn nine percent on surplus funds in the overnight rate from SBP. In fact, smaller and medium sized banks are already paying a higher rate to savers as compared to large network banks.
In our view, it is time for the big five banks to also come forward themselves and supplement the efforts of the State Bank by narrowing their spreads and offering higher than mandated profits to reduce the negativity on returns so far as possible with a view to raising higher level of domestic resources for the revival of the economy. Another vital step could be a closer consultation between the State Bank and the government at an early date, but certainly before the finalisation of the next year's budget, to identify priority areas where banks could be incentivised to provide more credit in order to accelerate the growth rate and achieve other socio-economic objectives. Adequate supply of energy at an affordable price continues to be the Achilles heel of Pakistan's economy. Without fully addressing this - there can be no turnaround in the real economy. This requires political will and sagacity which unfortunately appears to be missing. Through his "A Monetary and Fiscal Framework for Economic Stability," Milton Friedman (died in 2006) kicked off a controversy in 1948 by proposing that budget deficits should be financed through money creation. He thus proposed to combine monetary policy and fiscal policy, using the budget to control monetary emission in a countercyclical manner. In the case of Pakistan, however, it is an irony that the growing fiscal deficit has not led to deficit spending as a policy tool to help stimulate depressed economic conditions. No doubt, adoption of deficit spending as a strategy or approach will give birth to some legitimate fears about a further increase in interest rates as the government borrows more. But nothing can be more critical and critical than a profound acceleration in growth and job opportunities for a country like Pakistan where two million more people are adding to the job market annually. A significant decrease in joblessness should have a clear precedence over exacerbation in inflationary pressures.
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