There was no surprise in the Monetary Policy Statement (MPS) as status quo was maintained for another two months at 5.75 percent. The SBP sees a comfortable liquidity situation; but it remained silent on the fact that government borrowing from the central bank is back in business. The toll stood, on cash basis, at Rs874 billion in the first nine weeks of the fiscal year and is Rs1200 billion now. According to the SBP act, it has to be net zero by the quarter end ie the position ought to be reversed in three weeks.
Two weeks are already gone and there appear no signs of abiding to the regulations. During the IMF programme, the variation never reached such magnitude. It's a no brainer that this trend would have inflationary consequences. However, the practice of OMO injection by the SBP to scheduled banks, rerouting to fiscal consumption has similar affects.
Let's see, how long Dar continues with SBP borrowing to feed fiscal spending, which could be in expansionary mode, closer to the elections. That is why, inflation is likely to be rise in quarters to come, but will remain below 5 percent due to international oil prices. The monetary demand is already picking up; and consumer confidence is high, according to IBA-SBP consumer survey. This would imply further monetary expansion. Mispricing by large banks of assets has already started.
The problem is that net foreign assets are drying - NFA was Rs193 billion in FY16 as compared to Rs220 billion in FY15; and the position is even worse this fiscal, while the net domestic assets are on the rise. The deteriorating NDA to NFA ratio is a concern, as there is strong correlation between NDA/NFA to headline inflation.
There are supply side inflationary pressures as well. Commodity prices, especially those of food, are moving up. The SBP expects food inflation to be north of 7 percent in FY17, while the headline inflation is likely to be around 5 percent.
The current account is not showing a rosier picture either. Exports continue to fall and there is no respite to imports despite low oil prices. Relatively cheaper imports boost consumer demand further, and there are evidences of reverse of imports substitution as well ie domestic industry is slowly being replaced by cheaper imports.
There is no CSF money expected this year either to offer any respite to the current account less. The CSF flow was $937 million last year and $1.4 billion in FY15.
Home remittances, which have been growing in tandem with trade deficit to plug the gap for past many years, are losing steam. Not only its growth is consolidating, crippling Middle Eastern economies may dent inward remittances.
Both inflationary and current account pressures, along with expected expansionary fiscal policy call for some monetary tightening. At least, an era of easing policy should be over now. There are other ways than simply reducing the policy rate to spur growth, and there are other ways to check current account balance.
The SBP ought to be creative to look for options to incentivize or compel banks to lend to the private sector. One way is to put an upper limit on SLR to curb lending to the government. In case of latter, adjustment in currency can curb imports and potentially boost exports. But, that may not happen till 2018 elections; so it may be prudent to start thinking of tightening monetary policy soon.
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