So it begins. The second quarter has started off with a money squeeze. In order to meet IMF's conditions, the government massively retired its debt that it owed to the central bank - and to the surprise of many, it did not borrow further from commercial lenders.
This coupled with the decline in currency-in-circulation (CIC) - driven by post-Eid return of money in the system - gave some respite to the credit to non-government segment. However, the outflow in foreign assets amid a decrease in net domestic assets dragged money supply lower by Rs 46 billion (0.9%) in the first two weeks of this month.
A dissection of domestic assets indicates some sort of fiscal support funding emanating either from non-banking domestic source or an external source of late. Since, the major non-banking domestic source - National Savings Schemes - is unlikely to have fetched such a hefty amount in such a short period, the government must have received some support from foreign inflows to the tune of Rs 100 billion in the last two weeks. The Rs 37 billion increase in the size of 'other items' gives a clue.
With Rs 20 billion coming back to the system from the reduction in CIC, the additional liquidity with the multiplier effect in coming weeks is in the offing. Although, the reluctance of private sector amid cautious lending by commercial banks may not channel this liquidity fully to the private sector, we may see an increase of Rs 13 billion in coming weeks as local and global macroeconomic indicators stabilise amid noises of fresh export orders for the winters.
However, so far the week ending October 10 is concerned; the benefit of higher liquidity driven in the last two weeks was taken by public sector entities. Another reason behind the dryness in money supply is net foreign outflows and the government's withdrawals from bank deposits in an effort to retire its debt to State Bank of Pakistan. And considering that this government retirement is a one-off event in the quarter to meet its IMF target, one might see an increase money creation in the coming two months.
This together with likely release of IMF's third tranche worth $748 million, primarily for balance of payment support but flexibility to use some for fiscal support bridge financing portion, can generate some liquidity for banks to try kicking off the private sector. This view gains further strength by this week's reclassification of provisioning requirements for non-performing loan, which can boost the confidence of both lenders and borrowers to refocus on their respective businesses.

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KEY MONETARY AGGREGATES AS ON OCT 10
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                                                          RS (MN)
                                   10/10/09    9/26/09     CHANGE
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Currency in Circulation             111,700    131,322    -19,622
Total Demand & Time Deposits       -106,478    -79,926    -26,552
Broad Money (M2)                      5,482     51,659    -46,177
NFA                                 117,266    124,500     -7,234
NDA                                -111,785    -72,841    -38,944
Net Government Borrowing             76,357    177,024   -100,667
Borrowing for budgetary support      77,831    180,955   -103,124
from SBP                            -36,438     59,624    -96,062
from scheduled banks                114,269    121,331     -7,062
Commodity operation                      83     -2,648      2,731
Credit to non-govt sector           -13,934    -38,697     24,763
to private sector                   -81,181    -94,617     13,436
to PSEs                              68,093     55,925     12,168
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