Price stability is a pre-requisite for high and sustained growth rate of an economy. That is why it happens to be the most important goal of monetary policy all over the world. The Pakistan economy has been characterized by price stability in the past three and a half years i.e. July, 1999-December, 2002.
The State Bank of Pakistan (SBP) considers it no mean achievement. Periodically, the bank has been highlighting factors contributing to price stability.
We begin with the discussion of some of these explanations that are quite ingenious and novel. However, the object of this paper is to offer an alternative view underlining the fact that the real factors on which current price stability is founded do not augur well for the economy.
(1) “...inflationary pressures continued to wane, as growth in money supply is far lower than targeted for the second consecutive year”. (State of Pakistan Economy, January-March, 2000, p.1).
This is a lacklustre argument. The target set for monetary expansion could be too high in relation to unfolding economic situation. For example, original target set at 13.6 percent for 1998-99 was scaled down to 7.7 per cent in January, 1999, while actual monetary expansion during the year was of the order of 6.3 per cent. Moreover, monetary expansion at 15.4 per cent during 2001-02 and at 9.5 per cent during July-December,02 was far in excess of respective targets of 9.7 per cent and 7.8 per cent, while price inflation slowed down compared to earlier period.
(2) “SBP continued with the policy of sterilizing the monetary impact of foreign exchange purchases to contain the growth of reserve money (RM) and hence inflation. The principal benefit of sterilization is the containment of inflation.” (SBP: Monetary Policy Statement, January-June, 2003, p.5)
Monetary assets had gone up by Rs527 billion (or 37.6 per cent) during July 1, 2000-December, 02. Of this, increase in net foreign assets (NFA) of the banking system accounted for Rs.474 billion and expansion in net domestic assets (NDA) for Rs53 billion. It is hard to follow the argument that the principal benefit of sterilization is the containment of inflation.
(3) “Better availability of essential commodities due to a reasonable production of both food and non-food items, and availability of stocks from previous years had a moderating influence on inflation. The appreciation of the Rupee by 6.7 per cent also helped, by reducing the cost of imports.”
“As the SBP was able to substantially limit the growth of reserve money, it is hoped that inflationary pressures will be contained.” (SBP Annual Report FY02, p.6)
“Another important feature underlying the inflation that could also have reversed its deceleration was a relatively higher increase in money supply in FY02 compared with the previous year. However, a noticeable deceleration in the net domestic assets of SBP helped absorbing a significant increase in its net foreign assets that enabled the reserve money to expand at a much lower pace than that of money supply, thereby supporting the deceleration in inflation.” (SBP Annual Report, FY02, p.51)
The last two paras have been quoted just to show the level of understanding of SBP people, and need no comments. However, the SBP’s claim that better availability of both food and non-food items had a moderating influence on inflation is not supported by facts. The annual average growth rate of agricultural output at 1.6 per cent during the three years ended June, 2 and that of combined output of all commodity producing sectors at 2.0 per cent was well below the rate of increase in population at 2.3 per cent; thus indicating decline in per capita availability of goods. The effect of appreciation of the Rupee by 6.7 per cent on price level could not be significant.
The quotations from the SBP publications set out below clearly indicate that the management of the bank has been arguing at cross purposes; the reason being that they lacked clear perception of unfolding economic developments.
(1) “The monetary and credit policy will play its role in boosting domestic and export demand, while keeping inflation under control. Considerably low rates of lending, large liquidity with the banking system, fierce competition among the banks and lower remuneration on government securities are pushing the financial institutions towards new avenues such as consumer, mortgage, personal loans, SME and agricultural financing and targeting new customers particularly in middle class. This is likely to boost domestic demand....”(SBP, Oct-Dec, 2002, p.6)
2) “The production of consumer durables, especially of cars and jeeps, motorcycles, LCVs, etc. has been showing improvement over the last couple of years. The last couple of years have witnessed tremendous growth in consumer financing. However, the sale of consumer durables through hire-purchase became more popular lately when commercial banks expanded their coverage to individuals and aggressively advertised their products....
“As the interest rates are falling and competition is increasing, both leasing companies and commercial banks are expected to offer more attractive terms, and the number of customers is expected to increase. It is also hoped that the recent decision of the SBP, allowing commercial banks to provide financing facility for the purchase of consumer durables, will help the home appliance industry.” (SBP Annual Report FY02, pp.28-30)
Let us look at the whole situation in the light of well-known simple identity viz. MV=PY; where M stands for monetary assets, V for velocity of monetary assets, Y for real GDP (FC), and P for price level. The data for M, Y and P are readily available in SBP publications.
The data for turnover of total deposits and their components are also available. This is worked out by dividing total debits to deposit accounts with the average level of deposits during that period. A rough estimate of turnover of total monetary assets could be derived by assuming the turnover of currency in circulation equal to that of current deposits.
The monetary assets had expanded at a fast pace since July 1, 2000. At the same time, velocity of circulation of monetary assets had gone up considerably. This is evident from the fact that turnover of total deposits that had shot up from 13.7 in 1996-97 to 24.4 in 1999-2000 rose further to 28.4 in 2001-02; while turnover of current deposits after rising sharply from 55 in 1996-97 to 101 in 1999-2000, rose further to 114 in 2001-02. On the other hand, growth rate of output of commodity producing sectors fell short of increase in population.At the same time,cost-push factors,such as increase in prices of petroleum and its products,utilities,etc,and imposition of GST were in operation.fThese were sufficient grounds for a sharp rise in price level during this period. Then why price level remained relatively stable in the face of these developments?
To understand this phenomenon, we need to turn to two famous triads: (a) three functions of money viz. i) to act as unit of account, ii) as a means of payment; and iii) as a store of value; and (b) three motives of holding money: (i) the transaction motive; (ii) the precautionary motive; and (iii) the speculative motive. It is our considered view that with the progress in the implementation of financial sector reforms, there has been spectacular increase in speculative activities in the economy.
In support of this argument, the SBP quarterly report for October-December, 02 says: “The impact of the increased liquidity is evident in the spectacular 120.7 per cent Q2-FY03 increase in average daily trading volumes to 245 million shares. In fact, the dizzying rise in turnover ratio (value of stocks traded on the total market capitalization) in the latter weeks of the quarter, suggests that speculative interest was indeed a significant contributor to the rise during the period.” (p. 69) “This view is supported by the fact that badla volumes that had already risen significantly since July 2, rose outstandingly higher in the corresponding period. The badla rates averaged approximately 16 per cent in Q2-FY03, as against an average of approximately 12.7 per cent in the previous three quarters. Moreover, badla financing volumes too were 44.9 per cent higher during Q2-FY03, averaging Rs5.7 billion daily as compared to Rs.3.9 billion only in the previous quarter.” (p.70)
We may end this paper with a note of caution by Keynes (GT, p.159): “Speculators may do no harm as bubbles on a steady stream of enterprise. But the position is serious when enterprise becomes the bubble on a whirlpool of speculation. When the capital development of a country becomes a by-product of the activities of a casino, the job is likely to be ill-done.”
(Dr A.K.Niazi is former economic adviser of the SBP)
