The Credit Plan unveiled by the State Bank of Pakistan at the beginning of every fiscal year, would look like a dull affair to an ordinary person, but actually is significant for its impact on the behaviour of major economic variables like growth, inflation and exchange rate.
For the last few years the State Bank in consultation with the National Credit Consultative Council (NCCC), a body charged with the task of preparing the draft Credit Plan, has been pushing for an expansionary monetary and credit policy characterised by low interest rate environment and an almost unbridled growth in credit.
In the NCCC meeting chaired by the SBP Governor, on 17th July, 2004, monetary and credit developments in 2003-04 were reviewed as usual and targets set for 2004-05 that give a fairly good idea of the policy intentions of the monetary authorities of the country.
As for the 2003-04 monetary expansion at Rs 366 billion or 17.6, it percent far exceeded the target of Rs 230 billion or 11 percent.
This was due mainly to a substantial increase of Rs 326 billion (21.1 percent) in the net domestic assets (NDA) of the banking system as against a decline of Rs 4 billion in the preceding year.
The huge build-up in the NDA was due to the unprecedented increase of Rs 302 billion in private sector credit as against the credit plan target of only Rs 85 billion and higher than expected government borrowings from the banking system necessitated by the pre-payment of $1.17 billion to the ADB and lower accruals in the NSS.
As a result of growth oriented monetary policy of the State Bank, the private sector, according to the working paper presented to the NCCC, took full advantage of historically low interest rates.
All important sectors of the economy showed an increase in credit utilisation. Personal loans were up by 101 percent at Rs 60.9 billion.
Based on GDP growth target of 6.4 percent and inflation target of 5.0 percent, monetary expansion during 2004-05 has been envisaged at Rs 280 billion or 11.4 percent.
The NCCC was informed that a slightly lower rate of increase in money supply than the nominal GDP growth had been envisaged keeping in view the monetary overhang of the last two years and rising inflationary trend.
The private sector is projected to consume net credit of Rs 200 billion while government budgetary borrowings are targeted at Rs 45 billion in line with the government requirements as indicated in the budget.
Net foreign assets (NFA) are expected to exercise on expansionary impact of Rs 30 billion. With regard to private sector credit, it has been made clear that "in case the demand for credit is higher than the estimated, it would be met by all means as has been done during the past."
The SBP chief claimed that despite low interest rate environment, inflation edged up only marginally, particularly the core inflation which remained under 4 percent.
The monetary policy stance agreed in the NCCC is likely to be finalised and approved in the Central Board Meeting of the State Bank scheduled to be held in the next few days without any major changes.
However, from the proceedings in the NCCC meeting, it is quite obvious that the State Bank is in no mood to consider any major change in its present policy which has proved largely successful in the past few years.
The only lever that the State Bank had, according to the Governor, was the interest rate policy. Had the interest rates been increased, the main effect would have been a slower expansion of private sector credit, lower industrial growth and higher unemployment rate.
The expansionary monetary policy had brought the lending rates down to an all time low of five percent and increased the growth rate to 6.4 percent. Nevertheless, in our view, the same policy cannot lead to the same results for an indefinite period and has to be changed with the changed situation.
In the last few months, the rate of inflation has accelerated resulting in an increase of 4.57 percent in CPI during 2003-04 as against the target of 3.9 percent and the actual rise of only 3.1 percent in the previous year.
The Wholesale Price Index (WPI) rose even higher by 7.91 percent. Since WPI impacts the CPI with a time lag, the inflationary trend could get even worse in the coming months.
With the monetary overhang of the past few years when actual expansion in liquidity had exceeded the projections by a wide margin, accentuation in inflationary pressures in the economy is a real possibility.
In our view, this is the right time for the State Bank to start worrying about the emerging inflationary pressures and think about the ways to tighten monetary policy rather than insist on the old expansionary policy and assuring the private sector that its demand for credit would be met by all means.
Some deterioration in the exchange rate of the rupee in the recent weeks also calls for re-appraisal of the monetary policy.
There are also certain other distortions visible on the horizon. Interest rate structure at present is highly skewed in favour of borrowers and detrimental for savers.
In May, 2004, the weighted average lending and deposit rates stood at 5.42 percent and 1.21 percent respectively, leaving a high margin of 421 basis points for the banks to swallow. It means that depositors, generally the common people, are suffering a huge erosion in their purchasing power and it would ultimately have a negative impact on the saving rate of the economy.
The continued emphasis of the State Bank on consumer credit resulting in a jump in personal loans could also have serious consequences, particularly when the interest rates tend to rise. Such loans are not only promoting the culture of consumerism which would have adverse social consequences but could hit the borrowers badly since they would be obliged to pay higher instalments from their limited incomes at the time of rise in interest rates.
We would, therefore, advise the State Bank to look more closely at all the related aspects and not allow itself to be lured away wholly by the interest of private sector borrowers who, in any case, are presently getting loans at almost no net cost.