State Bank of Pakistan (SBP) will be making its monetary policy public today. As May inflation has already dropped 11.8 percent year over year, this is one of the most talked about subjects for business community right now.
It is true that decreasing food and oil prices have brought down inflation substantially in the last few months, but it is also possible that the fiscal year ends up at over 23.5% or 1.5% more than the target rate. The question is whether the inflation numbers of the previous months are sufficient to persuade the monetary policy committee (MPC) to lower the rate.
Real interest rate changes are positively tilting. Still higher, though, is the average CPI over that of the year before. As the national budget is due on Wednesday, June 12; therefore, the monetary policy statement is quite important and relevant.
Given that our monthly external deficit averages at about USD 3 billion and our current account deficit (CAD) from July to April is $ 202 million and our SBP foreign exchange reserves are $ 9.1 billion, the Pakistani rupee is expected to remain steady.
SBP monitoring and constructive actions have played a big role in stabilising the kerb market activity.
It is a fact that the higher growth in agriculture sector this fiscal year is backed by increased exports due to expansion in information technology (IT) industry, besides increased rice production.
Though rising, our wheat production is still less than the demand for domestic consumption. To reduce imports, our wheat production must increase faster than the population expansion. Economic success is not determined by the Pakistan Stock Exchange (PSX), a booming stock market; around the world, this is a typical phenomenon. Many advanced economies that have been through a nearly ten-year economic crisis and have managed to live on quantitative easing and ultra loose monetary policy, yet their stock markets have been touching new highs.
The economy of Pakistan; however, is hampered by considerably more serious problems. It has come to the point where it cannot float without the outside help. This is the main issue that has to be taken care of right now so that the nation may become less reliant on foreign borrowing.
While an alarmingly large SBP open market operation (OMO) injection of Rs 11.44 trillion combined (Conventional and Islamic) went overlooked for years at the highest levels (by the system and authorities), but without a full-fledged fiscal backing, monetary policy becomes insignificant. The impact of SBP OMO is so great that commercial banks are unable to offer significant credit to the private sector because of the amount of government paper (GoP Holdings of Rs 20.86 trillion or 71%), return on investments and risk concerns associated with the government assets.
Corporate sector balance sheets are so overcrowded that there is hardly enough lending room available. This explains why the banks’ advance/ deposit ratio (ADR) has dropped to 42.52% and may keep falling at this pace. This is the most important indicator of very low economic activity that has contributed to lower inflation.
However, restricting expansion hurts GDP growth, which lowers revenue collection, as well. The worst combination that discourages lending by private sector banks is this record high OMO injection and lowest ADR.
In June to May, the private sector received credit of Rs 106.35 billion, or $382 million; it ought to be about Rs 2 trillion in Rupees or $ 7.2 billion.
Due to reduced oil consumption, circular debt has not expanded significantly because lesser lending has slowed down the economic activity.
Moreover, the circular debt needs to be brought down; the rise in economic activity may drive it higher. If the economic activity picks up, by the end of next fiscal year, it might get close to Rs 3 trillion.
The reason behind our low tax-to-GDP ratio, below 10%, is because a slow GDP growth affects tax collection, which falls short of growth.
Everyone is aware that the low collection ratio is caused by the unreported size of the economy. Pakistan’s dilemma will be overcome if the nation can achieve more than 20% collection ratio; with this the inflation pressures will also subside.
High circulation of money is mostly caused by an undocumented economy. Though it is still at a very high level, the good news is that the amount of currency in circulation (CiC) has dropped from above Rs 9 trillion to Rs 8.85 trillion.
When the old currency notes are substituted with the new ones, it is unlikely if the CiC will not pick up. This writer has already forecast no change in the policy rate in his note to the SBP forecasters.
Nevertheless, the business community is exerting pressure and inflation has dropped to a record third time and there shouldn’t be a problem to cut the policy rate by one percentage.
However, the SBP policy rate cannot be lowered until the first quarter of the next fiscal year, if we are to follow the book and our pledge with IMF, the major lender. This is because annual inflation will end up a whisker over 23.5 percentage points. This author has already included some crucial macro-level recommendations in his proposal for the next budget. The enormous size of the economy has pushed itself up beyond our reach; hence, we must think big.
Copyright Business Recorder, 2024