Industrialists, traders and stock market brokers being the traditional borrowers from the banking system are once again on tenterhooks or very anxious and excited waiting for further monetary tightening that the State Bank of Pakistan will be announcing tomorrow (Tuesday).
However, the real crisis the monetary managers are facing is: (A) how to reverse the policy of absorbing oil payments from the forex reserves? And, (B) how to stop the government from continuous borrowing from the central bank, for its budgetary expenditure - resulting in massive currency note printing - which is at cross purposes with the SBP objective of monetary tightening to fight off inflation.
All economists agree that to complement monetary tightening, fiscal policy needs to play a supportive role as well. In Pakistan, this has not happened and is still not happening. The Federal government while making the Budget FY09 was advised to work the fiscal deficit on the basis of zero borrowing from the SBP and the retirement of Rs 84 billion stock of Treasury bills in the current financial year.
Contrary to SBP advice, the Ministry of Finance while fixing the 4.7 percent fiscal deficit target, pledged no fresh borrowing on a net basis from SBP in FY09. The budget makers committed themselves to reverse the previous policy of financing the galloping growth of imports through FDIs, portfolio investment and external borrowing through bonds and GDR issues and instead move to curb non-essential imports through adequate tariff changes and removal of subsidies especially on oil and food imports.
While some meaningful steps have been taken lately to adjust oil product prices, sufficient regulatory duties on imports in the budget were not imposed and the import demand continues to be skewed towards domestic consumption. SBP is using commercial policy to attempt to curb aggregate import demand by way of first imposing 35 percent cash margin on import items and later replacing it with abolition of forward booking on imports. This could slow down the pace of imports but will not reduce the demand.
Oil: The real challenge facing Pakistan at present is meeting the oil bill. At $126 a barrel, around $20 billion worth of crude oil and deficit POL products need to be imported. If the international price of crude rises to $150 a barrel, the oil import bill could rise to $26 billion. Where will the money come for this? The Saudi facility can give a breather but would not reduce the need for POL products.
Instead of allowing the oil imports financed from forex inflows - SBP under Governor Ishrat Husain, decided to make payment for oil from the reserves on the pretext of keeping volatility in the forex parity in check. SBP also agreed with the government view that the present strain on the external account may be of a temporary nature and could be financed through external borrowing, privatisation and post earthquake funds.
Well, these inflows have now dried up. And, the SBP forex reserves have depleted to $7.8 billion. In fact in real terms they are even lower ie $6.3 billion since SBP has conducted forward swaps with banks of around $1.5 billion. This means SBP forex reserves can cover only 10 weeks of imports.
SBP would, therefore, need to address the policy of intervention in the exchange rate and fund at least 50 percent of oil if not 100 percent oil import payments from trade inflows. While, at the same time shift the burden of education, health, travel including Umra to the exchange companies from the banks. At present, banks tap the exchange companies for squaring the credit card balances only.
Obviously, this will result in weakening the Pak rupee against the dollar on the free market known as 'kerb' market. This, however, will create the room for SBP to also readjust the rupee/dollar parity in real terms and keep Pakistani exports competitive.
Even after upward adjustment in ex-pump price of POL products, government subsidy towards POL is still of Rs 4 billion. Nearly all of it is on account of diesel oil - Rs 3.9 billion. The government needs to do away with this in one go. It will have a shock impact and it would drastically reduce growth. Even negative growth for a year or two coupled with a focussed effort to selectively concentrate on a few items besides textiles which can bring at least $1 billion each would be needed to bounce back to sustained growth.
There nothing to gain in signing free Trade Agreements (FTAs) with selective countries unless we can adjust the trade balance or the difference in value between imports and exports on a bilateral level. Unfortunately, however, the trade policy FY09 has miserably failed to address the key challenge. The current account deficit now touching 10 percent, unless addressed on a war-footing, will bring the growth down, regardless of a hike in lending rates and will also reduce the demand for private credit.
The negative sentiment is a direct consequence of the failure of present political leadership in creating the much-needed psychological confidence. At least, Shaukat Aziz and company sang a similar 'Qawwali' with a view to boosting the confidence of both the local and foreign investors and successfully kept them in good humour. The infighting within the coalition on judges issue as well as on how to tackle the geo-political challenges has had a very negative bearing on the economy. Economic managers can provide all the input they can but the acceptance for it has to come from the political leadership. Sadly, though, no one in Islamabad is listening.