After keeping the policy rate unchanged at 10.0 percent for almost a year, the State Bank of Pakistan (SBP) finally softened its monetary stance somewhat and reduced the rate to 9.5 percent per annum. In its Monetary Policy Decision released on 15th November, 2014, SBP has justified the change in its policy stance on the basis of a sharp decline in inflation, and containment of fiscal deficit. After noting the limited impact of floods and a favourable trend in global commodity prices, the State Bank has highlighted the fact that CPI inflation (YoY) in October, 2014 was down to only 5.8 percent. Such a sharp decline may be explained by smooth food supplies resulting, in particular, from the fall in prices of perishable items, falling administered prices including those of oil, low inflation expectations and a significant base effect. Further, "given the recent downward trend, the likelihood for inflation to end the current fiscal year on a lower plateau is high." On the fiscal side, the government has shown a considerable progress in curtailing budgetary imbalances and seems to be on course to achieve further fiscal consolidation. This would have positive implications for monetary management and a favourable impact on the private sector credit cycle. However, the SBP has also indicated the risks to these positive developments. A downward trend in inflation over the medium and long terms may not persist because of volatile prices of perishable items and oil and uncertainty about subsidy on electricity and levying of Gas Infrastructure Development Cess (GIDC). For fiscal consolidation in the long run, structural reforms to broaden the tax base remain imperative but uncertain.
State Bank is rather vague on the growth prospects this time. It says that "current low oil price could salvage some of the lost growth momentum" but growth in LSM would remain constrained due to energy bottlenecks. However, barring the limited flood-related damage to some Kharif crops, agriculture output was expected to perform better. Trade deficit was expected to remain under pressure but healthy growth in workers' remittances would continue to assuage the weaknesses in current account deficit. In response to ongoing efforts of the government, foreign exchange inflows would remain on track.
Although borrowers in general, particularly the business community and the government, would be somewhat disappointed by a modest cut in policy rate compared to their expectations, yet the State Bank's decision to adopt a cautious attitude at this stage in view of the impending risks to the relevant variables seems to be more appropriate to the evolving situation. It is true that a cut in policy rate was much lower than the reduction in CPI inflation but there is no certainty as yet that softening trend in prices is entrenched and would continue over the medium or long-term. Transitory factors affecting the price level could reverse their course anytime and withdrawal of subsidies and imposition of Gas Surcharge is still very much on the cards. Energy shortages, a lack of investment and poor law and order situation would continue to depress the economy with a negative impact on availabilities. Fiscal consolidation seen so far is also not a permanent feature due to structural impediments. It also needs to be noted that though the reduction in CPI inflation to 5.8 percent would appear to be a major achievement in the context of Pakistan, it still needs to be brought down further for a meaningful macroeconomic stability and in no way does it compare favourably with other developing economies. We know that representatives of trade and industry would have liked a cut of about 1.5 to 2.0 percentage points in the policy rate but, on balance, the State Bank's decision to "wait and see" before making a larger reduction seems to be entirely justified in the present conditions. Clearly, there would be more room for taking a bolder decision when fiscal deficit is down due to structural reforms, improvement in current account deficit is sustained due to shrinkage in trade deficit together with an increase in autonomous inflows and inflationary pressures are contained at around four percent or so per annum for a considerable length of time. Also, a bold reduction in the policy rate would have encouraged dollarisation of the economy and unnecessarily annoyed the IMF when the country's case for the release of dollar 1.1 billion under the EFF is going to be considered in December, 2015. The seal of approval for the country's policies from the Fund is particularly important when inflows from other bilateral and multilateral flows are also required for bridging the gap in external sector receipts and payments, maintaining foreign exchange reserves at the current level and checking the slide of the rupee on the currency market.
Several other factors may have also motivated the SBP to play safe at the moment and not to take a risk of a larger reduction in the policy rate. Historically, Pakistan has generally opted for premature easing of both fiscal and monetary policies. The unnecessary haste has often led to the re-emergence of macroeconomic instability and price pressures with a vengeance after a short period. Maybe that the SBP wants to avoid such a scenario this time. Besides, the business community often exaggerates the impact of interest rate fluctuations, whereas the interest cost is usually no more than 10 percent of the aggregate cost of production of a product. As such, cutting the interest rate by one percent could reduce the cost of production by approximately 0.1 percent. On the other hand, lowering of deposit rates as a result of decline in policy rate could negatively affect the saving rate of the country, narrowing the very pyramid on which banks' ability to create credit is dependent. In our view, it would be more productive for the economy and rewarding for the businessmen if, instead of pressurising the SBP, they would press the government to improve governance, physical infrastructure, delivery of services and maintain the exchange rate at a level, which could guarantee better competitiveness of Pakistani products abroad. A disproportionate emphasis on interest rates in the case of Pakistan is probably not the right approach.
It does not mean, however, that the State Bank has all the attributes of an ideal central bank and has no shortcomings. Its remarks in the MPS that healthy growth in workers' remittances would continue to assuage the weaknesses in the current account are quite ambitious and may not turn out to be true. Depressed oil prices in the international market, which the State Bank believes to be a positive development for balance of payments position, could also lower the demand for labour in the Middle Eastern countries and reduce or maintain the flow of home remittances at the present levels. Also, all the EFF targets missed by the country, including net domestic assets of the SBP, government borrowings from the central bank and net international reserves, relate directly or indirectly to the SBP. Such slippages could cost the country a great deal. Besides, SBP's supervisory role is as important as the formulation of monetary policy but placing KASB Bank under moratorium after it was in trouble for more than a year, does not inspire much confidence in the State Bank's ability to act in time. In our view, the State Bank should have acted somewhat earlier to save the depositors from an agonising situation and maintain the credibility of the financial institutions, which play a critical role in the development of a country. The argument that KASB Bank just had 0.6 percent of the total assets of all banks and depositors with balances of equal or less than Rs 300,000 would not be adversely affected would not be sufficient to keep the reputation of our financial institutions fully intact and is no solace for depositors holding balances of above Rs 300,000. Corporates having accounts in KASB Bank will not be able to meet their obligations towards their employees. It is also likely to create serious problems in the capital market as nearly 20 percent of trading turnover on the Karachi Stock Exchange is generated by KASB Securities, a subsidiary of KASB Bank. Unless the SBP exempts the transactions by KASB Securities from the limit of Rs 300,000 in KASB Bank, there would be a serious setback to capital market operations. It appears SBP has not thought through its action. Half-baked actions are worse than no action.
Comments
Comments are closed.