07 February 2005	Monday	27 Zilhaj 1425

The economic theory suggests that interest rates should be raised in order to contain or reduce the inflation. If we look into the economic position prevailing in the decade of 1990s , we find that the inflation could neither be contained nor brought down despite the raise in the interest rates to the extent of 15-22 per cent per annum. The interest rate hovered around 20 per cent per annum on the average in middle/late 1990s.

The State Bank of Pakistan (SBP) also auctioned Treasury Bills in that period at 16-17 per cent per annum.

Why this economic theory could not work in our case? Some people say that when the core inflation-mostly covering the food items rises, it cannot be contained or brought down through tightening of the monetary policy.

We have taken the instance of 1990s because with the advent of the fiscal year 2004-05 (FY-05), SBP has since abandoned the loose monetary policy stance and has started tightening the monetary policy by raising interest rates. Despite that inflation rose to over nine per cent by November, 2004 and decelerated to eight per cent by the close of 2004.

It is premature to arrive at a final conclusion about the interest rate at which FY-05 may end up, but the SBP has estimated that the inflation will rise to seven per cent as against five per cent estimated at the commencement of the fiscal year. It means that tight monetary policy will not be able to contain the inflation to the level of the previous fiscal 2003-04 (FY-04) when it was 4.6 per cent or five per cent estimated for FY-05.

Economists say that growth in the economy also increases the inflation. During FY-03, the real GDP grew by 5.1 per cent while the inflation increased by 3.1 per cent and in FY-04 the real GDP grew by 6.4 per cent while the increase in the inflation was of the order of 4.6 per cent. In other words, inflation was much below the economic growth rate during these two years despite pursuance of the loose monetary policy with low interest rates.

However, during the current fiscal FY-05, inflation is expected to remain at par with the economic growth rate or may surpass that. What does that indicate? From a lay man's view point, our economy has not gained such strength that it could respond to the enforcement of the economic theories set forth by our economists.

One-third of our population lives in extreme poverty while another one-third on just the subsistence level. The authorities should, therefore, devise policies for this majority with a view to containing or lowering the core inflation which is much higher than the CPI. However, no specific endeavour is visible in this context.

The current situation is that the price of sugar has risen by Rs2.00 per kg in the last two months. Around 1986, sugar crisis had arisen and in order to protect the interest of the consumers, SBP had banned any advances against sugar. Due to the projected shortfall in the sugar production.

The government has now allowed the import of raw sugar but SBP should also consider suitable measures under the monetary policy to guard against the hoarding of that essential item because even the current interest rate may not deter the hoarders.

Last year, wheat shortage had cropped and SBP admits that the bank loans were used by the hoarders. Despite that the SBP, very belatedly, put 50 per cent margin on advances against wheat some times in May, 2004 [instead of putting a complete ban on such advances] when- according to the press reports- the hoarders had already made black money of the order of Rs3 billion.

The government claims that the prices of wheat have come down in the recent weeks but this is not visible at least in the large cities. The prices of poultry have abnormally increased and the bakers are not behind in increasing the prices of the baked bread. The core inflation affecting the 2/3 of the population, does not appear to be subsiding for quite some time in future.

The purpose of tightening the monetary policy, inter-alia, is to restrict the expansion of the credit. During FY-04, credit to the private sector, as per SBP report for that fiscal, expanded by Rs325 billion. The monetary policy statement (MPS) released by the SBP on the January 19,2005 indicates credit expansion of Rs244.4 billion [19.2 per cent] during July 1-December (25) 2004 (MPS -05).

True that the economy is expected to grow at a rapid pace [at 7 per cent as against 6.6 per cent projected at the commencement of the fiscal] and the inflation is also increasing necessitating increase in the credit requirement by -say- 14 per cent or so. But this huge expansion of 19.2 per cent during the first half of the fiscal FY-05 hints towards mis-utilization of the credit in the unproductive avenues like real estates and the stock exchanges.

The rise of KSE 100 index from 5246.91 points [01-11-2004] to 6218.40 points [31-12-2004] without significant economic grounds can be cited as an instance. The assertion in MPS-05 that inflationary expectations are likely to remain at least for four key reasons including, inter-alia, rising trend of real assets prices. This is an indirect hint that bank borrowings are also being utilized in real estate speculation.

On page 9, the MPS-05 states that "the prospect of persistence of rising interest rates might have been another reason for pre-empting borrowers to increase their credit off-take". It is difficult to interpret this assertion whether rising interest rate perception is in favour of or against the heavy credit off-take in the private sector.

It is argued that there should not be any worry if the credit expansion remains limited to inflation plus GDP growth i.e.- say, up to 15 per cent for FY-05. A plea is also taken that during January-June, 2005, large scale retirement of bank loans are expected and that by the fiscal year end, credit expansion will come within the safe limits. Let us hope for the good.

The MPS -05 states that the growth of reserve money was the direct outcome of shifting of some of the treasury bill holdings of commercial banks to the SBP. When the Government borrows from the commercial banks through T/bills, it sucks up the liquidity from the market and the subsequent government spending levels up the liquidity in the banking sector and hence such borrowings do not have inflationary impact.

Contrarily, the government's borrowings from the SBP and its spending means pumping of additional money into the economy which definitely has the inflationary impact. The present gesture of retiring T/bill stock held by the commercial banks may have dual impact as it has not only provided additional money in the banking sector amounting to Rs166.2 billion but like amount will further be pumped into the economy when the Government spends money borrowed from the SBP.

At the time when, on the one hand, SBP is endeavouring to contain inflation, its simultaneously following the policy having inflationary impact on the other hand is beyond comprehension. It can be argued that Government's credit requirements were met through lending by the SBP because commercial banks were demanding higher interest rates which were not acceptable to the SBP but this argument can be outweighed in the context of the overall tightening policy being pursued by the SBP since the beginning of FY-05.

Another aspect can be that lending to the government would fetch some interest earning to the SBP but it could be ignored in the context of the overall policy, being the matter of secondary importance.

MPS-05 indicates that government's borrowings from the banking sector rose to Rs34.8 billion during July-December, 2004 as against FY-05 full year target of Rs45 billion. The reasons for higher borrowings have been enumerated as follows: (a) shortfall in non-bank borrowing budgeted for FY-05 (b) high foreign payments (c) bearing the brunt of high petroleum oil prices by keeping the petroleum prices intact since May to December, 2004.

The details of shortfall in non-bank borrowing have not been made available. The quantum of the revenue loss caused by freezing the petroleum prices has also not been given. The reports appearing in the media put it at Rs30 billion. This is, however, the one-sided story. Due to high imports and growing economy, tax collection is also above the targeted amount. In SBP quarterly report for July-September, 2004 the position of revenue collection during July-October,2004 has been given as under:

Collection Head  Target  Actual recovery



                [Figures in billion Rs,]



Direct taxes      37.8      48.5



Sales tax         70.1      70.1



Central Excise 



Duty              13.4      15.5 



Customs Duty      29.5      32.6



TOTAL            150.8     166.7