The State Bank of Pakistan appears to be willing to live with inflationary pressures as cost for accelerating economic growth as it grapples with conflicting objective of moderating pressure on exchange rate while simultaneously containing sharp movements in rupee interest rates.
The twin announcements to meet oil payments from foreign exchange reserves and to raise only Rs 11 billion through auction of Pakistan Investment Bonds until June next year are meant to ease the pressure on rupee-dollar parity and maintaining negative real rates until end-June 2005 are both tilted heavily in favour of growth with the objective to generate employment, say economists.
However, they argue that drawing down of forex reserves to meet oil repayments, and continuing with a policy of moving treasury bill yields steadily would result in the growth of monetary assets to outstrip the rise in nominal GDP for the fourth successive year.
The easy monetary stance adopted to kick-start a stagnant economy in the absence of a fiscal stimulus was successful in inducing a massive increase in aggregate demand leading to increased capacity utilisation in the economy, specially in the manufacturing sector driving the real GDP growth over six percent is not sustainable.
In fact, the 19.2 percent growth in money supply (M2) during FY04 was the highest in the past 12 years.
Same economists see a danger in SBP's persistence with the present policy as it could result in heavy borrowing by the government from the State Bank of Pakistan (which amounts to note printing) resulting in double-digit inflation by the end of next year.
Unlike the previous years ie FY02, FY03, the increase in money supply was fuelled by the foreign sector due to heavy inflow of home remittances and other one-off disbursement. In FY04 and FY05 the rise in money supply (M2) can be attributed to large rise in domestic credit - Rs 325.2 billion last year as against Rs 50 billion two years ago.
In the current financial year government borrowing from the banking system would substantially rise despite better revenue collection and higher non-tax receipts.
As it is, the government has adopted a policy of higher dividend payout from PSEs, which amounts to transfer of resources from the companies. Higher dividend payout from PTCL and OGDC makes them vulnerable, as they cannot meet the expansion plans from their own resources, say the economists.
The monitory overhang of previous years has filtered into inflationary pressure. The GDP deflation is the broadest measure of inflation, but is available on annual basis. The dominance of domestic factors is most clearly visible in the GDP deflator, which has risen by 6.8 percent in FY04 as against 4.2 percent a year ago.
The SBP's monetary statement clearly indicates concerns over monetary overhang in the economy and states that the SBP would only seek to avoid a "significant" weakening of the economy.
FY05 started with 8.5 percent rise in Consumer Price Index. Since then inflation has been on the rise and this could end with year to year June 05 in double digits, fear the economists.