A positive nod from the Central Board of Directors of the State Bank to reduce liquidity injected through open market operations (OMOs) in a phased manner, as reported by this newspaper on 11th February, 2013, would appear to be a welcome move because of its likely impact on containment of demand and softening of inflationary pressures on economy. Tracing the trend of liquidity injection in the system through OMOs, it was pointed out that outstanding OMO at the end of June, 2011 was Rs 92 billion but the average for FY11 was minus Rs 4.1 billion, which meant a net withdrawal.
In FY12, the end-year outstanding figure was Rs 79.9 billion, with the average of Rs 208.5 billion during 2011-12. However, in order to ensure that the payment and settlement system keep rolling and meet the rising liquidity needs of economy, the SBP had to gear up its liquidity injections during the current year. From a mere Rs 80 billion at the end of June, 2012, the outstanding injections through the OMOs rose to Rs 611 billion by the end of Q1-FY13. This sizable injection has been, more or less, consistently rolled over during the later part of the year, with the average outstanding injections standing at Rs 578 billion by 7th February, 2013.
The implications of sucking liquidity through the OMOs as assented to by the Central Board of Directors are obvious and must have been analysed by the State Bank in detail. Nonetheless, as is well known, the SBP, in its various documents, has all along been claiming that huge injections of liquidity through OMOs were necessitated by the crucial need of keeping the payment and settlement of the banking system rolling. As such, the reverse measure approved by the Central Board of Directors would have the opposite impact if all other things remain unchanged. To begin with, there will be a liquidity crisis and payment difficulties in the system, resulting in all sorts of problems including a business slowdown and insolvency in certain cases. The government would also not be able to borrow the required funds and be constrained to stop payments and reduce all kinds of expenditures to a certain extent. Therefore, there could be an onset of recession in the economy, the growth rate could decline and unemployment increase further. All of these problems, can, however, be mitigated to a certain extent if a conducive environment is created to neutralise the negative impact of reduction in liquidity through reverse OMOs. All the economists know that money/liquidity is generally pumped into the economy through three main sources, ie, the expansionary influence of government sector, private sector and foreign sector and can also be pumped out through the contractionary impact of these very sources. It is very easy to show how these sectors influence the level of liquidity / money supply in a country. While the foreign sector is usually an exogenous, dynamic and largely outside the control of the monetary authority, the SBP can play a role in determining the behaviour of private and government sectors. Tightening of monetary policy or rise in policy rate is generally geared towards containing credit in the private sector and curtailing money creation through this source. It is, nonetheless, difficult for the central bank usually to control the behaviour of government sector which depends on a host of factors. Coming specifically to the case of Pakistan, any further reduction or slowdown in the availability of private sector credit would have serious consequences for the country's economy. As such, the only plausible alternative left for the State Bank is to successfully persuade the government to reduce its dependence on the scheduled banks for budgetary borrowing and let the released liquidity find its way into the system to offset the negative impact of reduction in liquidity through reverse OMOs. This can only be done by raising more revenues through means such as foreign sources, a significant reduction in expenditures and increased reliance on non-banking sources to meet a large part of the fiscal gap. We fully appreciate the difficulties in each of these areas and the reluctance of the government to follow a prudent path of fiscal adjustment to suit the objectives of monetary authority. We, therefore, appreciate the resolve of the Central Board of Directors to reduce liquidity in the system and wish them good luck but are also aware that the government is not likely to cooperate in such an effort, particularly at this juncture. As such, a legitimate and laudable objective would, unfortunately, remain unfulfilled despite the intention of the State Bank to follow a more sensible policy option.