The Board of Directors of SBP, in its meeting held on 19th July, 2014, decided once again to leave the policy rate unchanged at 10 percent for the next two months. A status quo was widely anticipated as the economy was still not out of woods despite improvement in some of the key macroeconomic indicators. According to central bank's Monetary Policy Statement (MPS), economic indicators are certainly better at the beginning of FY15 than a year ago: foreign exchange reserves were considerably higher, forex market had stabilised, growth in broad money (M2) was contained due to a deceleration in government's budgetary borrowings, private sector credit was picking up along with a moderate economic recovery and inflation remained in single digit. More specifically, year-on-year growth in M2 had decelerated to 12.5 percent by end June, 2014 - the lowest rate of monetary expansion during the last three years. This was mainly due to a significant reduction in government borrowings for budgetary support from the banking system that provided necessary space to the private sector to borrow from banks; it also led to lowering inflationary expectations. The growth in domestic debt during FY14 had decelerated due to a lower fiscal deficit and increase in external financing. Foreign inflows had resulted in a capital and financial surplus of dollar 6.1 billion during July-May, 2014 which was a marked improvement compared to the surplus of only dollar 465 million in the corresponding period last year. From a low level of dollar 2.8 billion on 7th February, 2014, SBP's foreign exchange reserves had increased to dollar 9.6 billion by 4th July, 2014 and exchange rate had stabilised slightly below Rs 99 to a dollar. The average CPI inflation at 8.6 percent in FY14 was in single digit for the second consecutive year. Thanks to a better LSM performance, real GDP had grown by 4.1 percent in 2013-14 despite challenging security conditions and energy shortages.
However, SBP has warned that "continuation of prudent policies and reforms is needed to build on positive developments and achieve protracted stability". For instance, only comprehensive tax reforms could reduce fiscal deficit and keep M2 expansion within safe limits. Similarly, energy sector reforms could provide a critical impetus to economic growth, help reduce import bill and thus ease pressure on balance of payments (BoP). Deposit growth of 12.6 percent in FY14 needs to be improved. Sustainability of government borrowings from the banking system was contingent on a further reduction in fiscal deficit and continuation of external financing. A major risk to the fiscal position in FY15 is from the revenue side as FBR revenue target of Rs 2.81 trillion looks quite challenging, given the current narrow tax base. With C/A deficit projected to remain 1 percent of GDP in FY15 along with some other positive developments, foreign exchange reserves are expected to exceed dollar 13 billion by end-June, 2015. Main risks to this assessment were, however, uncertainty over international oil prices and possible delays in planned foreign inflows. "Sustaining this trend, especially in the post-IMF programme years, would require additional efforts and reforms," the SBP has remarked. A significant appreciation of the REER would need to be monitored carefully. Besides, improvement in country's security conditions was critical in attracting non-debt creating financial inflows.
Though one could easily find fault with the State Bank's approach of giving a positive spin to certain developments and overlooking the vulnerabilities of the economy in its MPS, yet its decision to keep the policy rate unchanged at 10 percent seems to be an appropriate response to the situation. The maintenance of this rate since November 2013 is largely due to the fact that fundamental factors affecting the policy rate do not seem to have sufficiently taken a positive or negative turn on a sustained basis and the overall situation is still fluid. For instance, behaviour of CPI, a key determinant of the monetary policy, has not changed much and the target for the year has been missed. Balance of payments (BoP) situation is much better than before but the main drivers of improvement are either on-off receipts or debt creating financial flows which cannot be relied upon to give comfort to the external sector for the medium or long-term. In fact, exports which could provide a longer-lasting boost to the external sector, of late, have shown a declining trend and this should be a matter of great concern to policymakers. Appreciation of the REER seems to have widened the trade deficit and increased the risks in the foreign sector but the SBP has preferred to advise the government to monitor the situation in a very mild manner rather than taking a tough stand in favour of rupee depreciation in order to have a proper balance in the external sector through autonomous inflows.
State Bank has also either ignored or spoken very lightly about some of the other issues. For instance, it has not mentioned in its MPS the continued violation of FRDL Act, 2005 which has faded this law into near insignificance and could be a major source of instability in the years to come. Also, the SBP has not focused to explain the relationship between foreign borrowings, reduced fiscal deficit, release of banking resources for the expansion in private sector credit etc. Seen closely, most of these positive developments owe their origin to the success of the government in borrowing from various sources or convincing a friendly government to assist the country in time of need, and in no way could be attributed to the structural reforms or merit appreciation. On the other hand, such tactics of alleviating problems of the economy could put a lot of burden on future generations and limit the scope of the incoming governments for economic policy formulation. The State Bank has also preferred to keep mum on the risks of contracting foreign loans through the Eurobond and other sources in order to contain the level of budget deficit and give a boost to the external sector position. Besides, this MPS is silent on the current controversy on growth figures for FY14 and doubts about the accuracy of price data expressed frequently by certain sections of society. Most analysts who include certain multilateral institutions are of the view that real growth rate was not as high as 4.1 percent in FY14 and the rise in CPI was understated and could actually be much higher due to excessive increase in liquidity in economy, unaccompanied by a similar increase in availabilities in the country. Some sceptics are of the view that the SBP has become less critical about the government's policies and adopted a soft attitude after the changing of the guard at the SBP. If this is so, we would urge upon the SBP to be highly objective in its analyses strictly in accordance with its credibility and reputation.
Anyhow, notwithstanding these shortcomings, the tendency on the part of SBP not to bow to the pressure groups to ease monetary policy, bodes well for the economy. The onslaught of speculative forces to replace dollars with rupee holdings is also over, imparting stability to the rupee rate and keeping the inflationary expectations in check. An unprecedented development this time is the decision of the Board to publish the summary of minutes of monetary proceedings of the Board meetings in four weeks. We are hopeful that such an action would be of educative value for the students of economics and public at large and motivate the Board members to make a greater contribution to the monetary policy formulation of the country. We hope the minutes would also reflect the diverse and informed views of professional economists.
Last but not least, Business Recorder would like to know what exactly constitutes government's growth model. We have our doubts because if it is based on debt creating inflows it is not sustainable and we would like it to be an export-led growth paradigm . The country has been missing the revenue collection targets for the last six years. Lower productive spending - capital expenditure and the revenue grants for capital creation in areas such as public infrastructure, education and health - leads to muted economic growth.