"Although the final consolidated fiscal deficit during first three quarters of FY09 was within target, higher expenditure related to IDPs and security in the fourth quarter of FY09 has resulted in more than targeted fiscal deficit. Despite the likely slippages from the budget estimates, the fiscal deficit for FY09 is expected to be lower than the 7.6 percent deficit of the previous year..."
This part of monetary policy statement (MPS) has not only shown that we have missed provisional fiscal deficit of 4.3 percent by decent margin for FY09 but also indicates the need for high government borrowing in near future.
The most pronounced concern cited in MPS is heightened government borrowing for budgetary support and the fact that this trend will likely continue in the current fiscal year. One can infer from the underlying tone of MPS that the chief reason behind a modest rate cut despite dearth in private sector off-take and subdued inflation is to let the government borrow comfortably from local sources (commercial banks and national saving schemes) at attractive rates.
While this questions the extent of central bank's autonomy at one end, at the other, this implies a double blow for private sector credit off-take; a) not reducing adequate rate would restraint private sector to raise capital; and b) higher government borrowing crowds out the availability of credit to private sector.
In sharp contrast to declining private sector credit, the government borrowed Rs 317 billion between April and July, in addition to Rs 520 billion raised from treasury bills auctions. This explains the deposits' growth of Rs 279 billion versus a meagre growth in advances of Rs 95 billion (mostly to the government) in Apr-Jul period.
The second most important element is the investment-saving graph on the title page of the MPS: July-September 2009. Although, this gap is reducing, due to a decline in investment that in itself, not a good omen, it is still at 3.1 percent, which means that a substantial amount of foreign savings is required to bridge the gap. In the absence of a reasonable inflow of FDIs, the onus is on foreign debt flows, putting pressure on external balances. Thus, to stimulate domestic savings, an aggressive cut might not have been a prudent move or decision.
The foremost risk and challenge to our economy mentioned in MPS is power shortage, widely interpreted as the root cause of economic slowdown leading to a high incidence of bad debts in the banking system that in turn limits the credit to private sector even more. The solution to this problem partly lies in resolving the circular debt.
"With the government has shown resolve to address these issues in this fiscal year, their likely positive impact on the economy may take some time. In the interim, the cost of delayed adjustments will be absorbed in the budget with consequent repercussions for inflation and thus monetary policy stance in future"
This part of MPS indicates the cautious stance in upcoming interim reviews. In our recent interview with the MD Pakistan State Oil (to be published soon in Business Recorder), we found out that PSO may contemplate halting its operations in the absence of circular debt resolution. This implies virtually no power in most parts of the country, which the government would never let happen; hence the financing for circular debt becomes imperative. Moreover, withdrawing power subsidies is inevitable, implying higher inflation.
All these converge to point out that the shape of our economy is still fragile, although a fall in CPI is reassuring which, it seems, validates the direction of economic policy - government revenue constraints, inevitable security, energy-related and other current expenditure, power crises and high investment-saving gap underscore the need for the sustainability of improved macroeconomic indicators, like, subdued inflation and rebuilding of foreign reserves.
Most of these problems are not in control of monetary managers, as any movement in discount rate is constrained by implicit fiscal pressure. Nevertheless, full credit should be given to SBP for an insightful policy analysis, the introduction of a 'corridor' for the money market overnight repo rates and the setting up an independent monetary policy committee on the pattern of Bank of England with a view to enhancing overall transparency and creditability.
The binding floor of reverse repo rate at 300 basis points below policy rate to follow one of IMF's stipulated conditions will surely help reduce volatility in market rate. IMF's country report on Pakistan said, "The SBP's reverse repo rate will be ceiling, and a standing repo facility to absorb excess liquidity from commercial banks will serve as the floor of the proposed explicit". The implementation of this mechanism will keep short-term interest rate movement confined in a band of 300 bps. This will not allow access cash in the system, hence, reduce the pressure on exchange rate movement in short term.
Another step of increasing MP reviews, ie, two half-year full-fledged reviews and four interim reviews, would give State Bank more room to act on changing global and local macroeconomics environment. This will allow the central bank to proactively act on volatile international commodity prices - something on which our economy so much depends on. The upcoming reviews would be governed by movements in international oil prices that are the helm of our current account, fiscal and energy balances.
It is also pertinent to note that while the SBP has the latest numbers (fourth quarter FY09) on fiscal position; these have not been made public for independent analysts. If the government can release all the key indicators to IMF and SBP, why can it not timely disseminate the information publicly?