The speech from the acting governor State Bank on Friday was more of a lecture to the fiscal managers to tighten their ropes than an address on pricing issues vis-à-vis inflation. This reminds one of Dr Shaikh's maiden budget speech last month when he attempted to deliver an Econ 101 crash course to fellow parliamentarians rather than announcing the much-needed fiscal austerity steps.
So while the professionals at the Ministry of Finance are busy convincing legislators that lack of political will is detrimental for economic stabilisation, the hawkish monetary managers are hammering out their fiscal counterparts by increasing the cost of their borrowing to check inflation.
Inelastic demand for fiscal borrowing, however, will remain indifferent to the hike in interest costs and the government will most likely continue to knock on the doors of central and scheduled banks to fill its ever increasing appetite. In the meanwhile, private borrowers at the helm of the provincial and central government rift and the central bank's stick will be further cornered.
Hopes of political resolution over consolidated fiscal discipline amid emerging external risks have faded away within six months - from favouring 'no tightening' in January the views of all monetary policy members shifted 180 degree to 50-bps hike in July.
Given the changing perception on how to deal with the recessionary environment across the globe in the aftermath of the Euro zone crisis, the fiscal catastrophe is doing no good to the ailing local industrial sector and, in turn, consumers.
Despite risks to global recovery, the growing global debate on whether to cut or to expand economic stimulus is moving in favour of the curtailing fiscal deficits to counter the looming debt trap. Pakistan's economy, much vulnerable to external shocks and internal rifts, has to follow the same by slashing fiscal gaps.
The current external account, which improved in FY10 owing to lower imports growth, robust remittances growth and CSF inflows, might worsen in the ongoing year. High import growth, low export growth, elusive foreign aid flows and low FDI owing to bleak security situation might take it back to square one.
More importantly, even after being in the IMF programme with stringent fiscal conditions for almost two years with common knowledge that the biggest fiscal problem is the low tax to GDP ratio, FY10 proved to be a disastrous year in this regard. As the tax to GDP ratio for the outgoing fiscal year is at a forty years low, according to SBP.
The passing on of subsidies to consumers is the right approach but continual increase in electricity tariffs is a double-edged sword. The energy shortage and expensive energy will not only hinder the new industrial investment but also fuel inflation further.
The increase in salaries of the armed forces' followed by a hike in the government employees' compensation threaten the wage spiral inflation whereas the private sector is busy designing and implementing cost cutting solutions.
The incidence of taxes is further skewed towards indirect taxes. With no visible steps taken to broaden the tax base, the most visible measure taken is the hike in the rate of GST. This will put further pressure on prices and tax incidence of low-income households.
The SBP categorically cast doubts on the achievement of FBR's tax collection and fiscal deficit targets for FY11. How could any sane mind expect a consolidated fiscal deficit of four percent with a surplus of one percent from provinces when all provinces are showing deficits in their respective budgets?
This is a shame for a country where monetary managers are implicitly tightening the ropes of the government.
The government might continue borrowing from domestic sources at higher costs, and to repay these loans it would require further borrowing. Putting reins on falling investment levels, which are at a decade low level, will remain a headache for the policymakers. The hike in policy rate, intuitively, will further dent it.
Low investment means low future output, higher unemployment and low purchasing power. This might apply brakes on aggregate demand growth, but the stagnating aggregate supply will keep the gap at undesirable levels. The SBP can check it through pricing power which it did on Friday, but that has its own repercussions.
It's a vicious cycle that will keep on hurting private borrowers and consumers.
MONEY AGGREGATES
The week ending July 16 was dull as far as monetary numbers are concerned. With virtually no change in currency in circulation and marginal fall in demand and time liabilities, broad money fell by a mere 0.28 percent or Rs16 billion.
NFA fell by Rs13 billion while NDA largely remained unchanged to summarise the assets side of monetary aggregates.
The government lowered its borrowing from the central bank by Rs13 billion, albeit it's still standing at Rs64 billion for the first 16 days of the fiscal year. On cash basis, it breached the net zero target by Rs60 billion after missing by Rs42 billion in FY10.
The private sector borrowed Rs9 billion for the week ending July 16, but retired Rs42 billion for the first 16 days of the fiscal year. The private sector may borrow some in the first and second quarters owing to seasonal retirement of commodity finances and its own working capital requirement. Nonetheless, the government's ruthless fiscal actions amid SBP's hawkish stance will likely crowd it out in FY11. (Feedback at ali.khizar@br-mail.com)

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KEY MONETARY AGGREGATES AS ON JULY 16
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                                         Rs (mn)
                                   16-Jul      9-Jul     Change
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Currency in Circulation            57,175     59,587    (2,412)
Total Demand & Time Deposits     (131,811)  (118,182)  (13,629)
Broad Money (M2)                  (74,588)   (58,531)  (16,057)
NFA                                (2,042)    11,625   (13,667)
NDA                               (72,546)   (70,155)   (2,391)
Net Government Borrowing           49,444     56,110    (6,666)
Borrowing for budgetary support    60,337     64,608    (4,271)
from SBP                           64,993     77,727   (12,734)
from scheduled banks               (4,656)   (13,119)     8,463
Commodity operation               (10,875)    (8,491)   (2,384)
Credit to non-govt sector         (45,312)   (54,599)     9,287
to private sector                 (41,807)   (50,560)     8,753
to PSEs                            (3,555)    (4,089)       534
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Source: SBP
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