The government has said that the State Bank of Pakistan would review its stance for monetary policy in the next fiscal year by taking all available macro developments. Before that it would continue tight monetary policy until inflationary pressures ease off.
According to 'Economic Survey' released on Sunday in Islamabad, the easy and accommodative monetary policy stance that had been pursued during the last few years by the SBP underwent considerable changes during FY05, switching from broadly accommodative to aggressive tightening in the second half of the last fiscal year, more so since April 2005.
Overall inflation in general and core inflation in particular continued to exhibit a rising trend during the fiscal year 2004-05, the overall inflation reaching as high as 11.1 percent and core inflation at 7.8 percent in April 2005. In order to arrest the rising trend in inflation, the SBP changed its monetary policy stance to aggressive tightening in April 2005 by raising discount rate from 7.5 percent to 9.0 percent. The same tight monetary policy stance continued during the current fiscal year despite declines in both core and overall inflation.
The 'Survey' said that notwithstanding the tight monetary policy stance the SBP continued to strike a balance between promoting growth and controlling inflation, on the one hand, and maintaining a stable exchange rate environment, on the other. Tight monetary policy stance is likely to continue until inflationary pressures are significantly eased off. However, the SBP will review its stance for the next fiscal year by taking all available information regarding inflationary expectations as well as other macroeconomic developments.
The net bank credit to the government, used for financing commodity operations and budgetary expenditures, amounted to Rs 7.3 billion during July-April 22, 2006 against the annual target of Rs 120 billion and net borrowing of Rs 14.3 billion during the same period of last year.
While credit to government for commodity operations continued to decline throughout the year, credit to government for budgetary purposes continued to rise (primarily from SBP) until the receipt of funds from privatisation and issuance of bonds between March 31, and April 13, 2006.
The net credit to government for budgetary purposes, which had peaked at Rs 162.2 billion during July-March 11, 2006 (credit to government from SBP had also peaked at Rs 168.2 billion during the same period), sharply reduced to Rs 43.3 billion compared to the annual credit plan target of Rs 98 billion and Rs 15.0 billion borrowed in the corresponding period of last year.
The net budgetary support to government decreased by about Rs 115 billion between March 31 and April 13, 2006 due to the inflow of proceeds from privatisation ($1.12 billion) and sale of bonds in the international capital market ($0.8 billion).
If these proceeds had not been materialised the credit to government for budgetary purpose from SBP would have totalled Rs 170 billion.
Higher government borrowing for budgetary support reflects large spending on earthquake related activities. Monetary expansion in fact picked up substantially after the October 8, 2005 earthquake when broad money supply grew by 5.6 percent after a contraction of 1.2 percent during the first quarter (July-September) of the current fiscal year.
Despite tight monetary policy stance of the SBP, credit to the private sector increased substantially; it grew by 20.2 percent (Rs 345.1 billion) during July-April 22, 2006 compared with the growth of 28.0 percent or Rs 357.4 billion during the same period of last year. Credit to private sector continued to exhibit strong demand, reflecting the confidence of private sector on the continuously improving macroeconomic fundamentals of the country.
During the last three years (2003-05) the cumulative credit flow to the private sector amounted to Rs 931 billion, surpassing the total credit flow of Rs 580 billion in the previous ten years (1993-2002) by 61 percent. Net private sector credit-to-GDP ratio also rose from 0.5 percent in 1999-2000 to 5.9 percent in 2003-04, and further to 6.7 percent in 2004-05.
In the first nine months of the current fiscal year, the net private sector credit-to-GDP was 4.7 percent and is likely to rise further by the end of the current fiscal year. Although, the credit demand of the private sector remained strong, its growth nevertheless slowed considerably, declining from 28.0 percent to 20.2 percent owing to the tight monetary policy pursued by the SBP. The weighted average lending rate increased by 193 bps to 10.14 percent.
It is worth pointing out here that despite considerable credit off-take the distribution of credit to the private sector is still heavily tilted towards capital-intensive sectors and hence the flow of credit to priority sectors like SMEs and agriculture including livestock is still low. Therefore, there is a need to channel more bank credit to these sectors for greater job creation and poverty alleviation.
The distribution of credit to the private sector during July-March FY06 was broad-based.
INTEREST RATE TRENDS: The SBP continued to exercise tight monetary policy stance and therefore it intervened quite frequently in the interbank money market to achieve the desired results; it conducted 82 OMOs and withdrew liquidity to the extent of Rs 486 billion (with average maturity of 8.3 days) against the injections of Rs 383 billion (with average maturity of 4.3 days) during July-April FY06. Therefore, average overnight rates remained above 7.8 percent for most of time since July 2005.
Cut-off yields on 6-month and 12-month TBs since July 2005 rose by 30 bps to 8.29 percent and 34 bps to 8.79 percent, respectively (see Table-6.8). The average lending rate increased by a hefty margin, ie, 193 bps to 10.14 percent during July-March FY06 due to the lagged impact of 5-6 percentage point increases in cut-off yields on various TBs last year. It is for the first time in many years that the inflation - adjusted average lending rate has turned positive. It is expected that the private sector would now be more selective and prudent in terms of availing bank credit.
The tight money market conditions were also reflected in rising interest rates in the secondary market, particularly the short-term interest rates as 6-month and 12-month KIBOR rose by 110 bps to 9.56 percent and 67bps to 9.75 percent, respectively. The long-term interest rates did not experience any significant changes from their trend levels due to lack of activity in long-term papers in the absence of PIB auctions for two consecutive fiscal years. Therefore, the higher pace of hike in short-term interest rates relative to long-term rates flattened the yield curve.
The tight money market conditions also led the banking industry to raise the average deposit rate by 90 bps to 2.75 percent. However, this rise was not enough as the banking spread further rose by 103 bps to 7.39 percent since July 2005.
Strong demand for T-bills continued in the current fiscal year also. The SBP accepted Rs 688.8 billion from the primary market of T-bills during the first nine months of the current fiscal year compared to Rs 1052.0 billion in last year.
During July-March 2005-06, 65.1 percent of the bid amount (Rs 1058 billion) was accepted by the SBP, compared to 65.0 percent of the bid amount during 2004-05.