SBP’s monetary policy for July-December is not just another announcement. It is a carefully worded expression of its advisory role – something that was missing for quite a while. The fact that SBP proposes to act as a dispassionate evaluator of the government’s economic policies holds out the promise of restoring inter-policy balance.

According to the monetary policy, “despite the forecast for continuation of strong global growth, inflation outlook is uncertain with output gaps closing in many economies, and continued rise in oil and other commodity prices.

In economies where this has resulted in widening of trade imbalances, the burden to take corrective measures has fallen disproportionately on monetary policy and has often required concurrent adjustments in fiscal imbalances” (which are often not implemented).

The excerpt is significant because it points to the need for policy coordination to remedy economic imbalances. It begins to sound more apt if one recalls the sustained lack of coordination in Pakistan’s policy-making apparatus because what one policy initiative achieves is undermined by gaps in other policies. Look at, the gap between the pace of industrialisation and expansion of power generation capacity, import liberalisation and the resultant current account deficit, and economic growth that is characterised more by consumption than investment.

A craving for setting expedient targets with scant regard for the outcome of pursuing policies to achieve them characterizes our policy-making. Such imbalances create distortions that are capitalised on by clever market players.

Monetary policy laments the lack of coordination between state policies when it says, “in the face of exogenous shocks (e.g. unexpectedly high oil prices) to the economy it would have been desirable for the fiscal policy to be more supportive of monetary policy in containing aggregate demand and inflationary pressure”, and goes on to highlight the fact that, “strong demand pressures coupled with trade liberalisation played a vital role in swelling the external pressures on the economy”.

Expansionary fiscal, trade and monetary policies pursued during 2003-06, allowed demand to stretch beyond manageable proportions. SBP’s predicament in containing demand (without support from concerned government ministries), particularly the ministry of finance, must be taken seriously because the ministry’s policy to allow inflationary pressure, to “bleed over an extended period” rather than contain it quickly, fuelled import-led demand.

Finally, what continues to make things worse is that “domestic productive resources are over-stretched as nearly all sub-sectors of the commodity producing sector have shown below the target growth. As a consequence of the mismatch between demand and productive capacity, pressure on the external account and inflation are still very high”.

The apprehensions expressed about the efficacy of options (privatisation and external borrowing) to contain the current account deficit are valid, but the emphasis on supporting the export sector by “improving infrastructure and removing transportation bottlenecks to lower delivery lags and costs” although valid as a long-term strategy, is not the solution to Pakistan’s needs in plugging its current account deficit in the short-term. A more workable option – raising tariffs on import of goods with marginal utility – has not been cited by the policy.

However, the other policy recommendations are thought provoking for the ministry of finance, especially the one about broad basing government borrowing by cutting its reliance on the banking sector. In this context, the policy warns about dangers of “heavy reliance” on borrowing from the central bank and thus “contributing significantly to growth in reserve money”, indicating in that context a shade firmly that “this cannot be repeated in FY 07”.

The policy opposes state reliance on T-Bills to contain the huge asset-liability tenor mismatches government has created and recommends issuing, “additional long-term debt to finance the requirements emanating from the fiscal gap for FY 07” and, use “the right blend of non-inflationary borrowing mix from commercial banks, non-banks and external sources”. This way the government won’t consume private sector’s share in bank credit, and push up both interest rates and inflation. The policy also recommends banks and corporations to float long-term securities.

The recommendations are significant because they aim to restore a savings culture that was undermined by over-consumption, and to force the economy managers at all levels to desist from living on a day-to-day basis. They must all the time prepare for facing up to a future that grows dangerously uncertain with each passing day. No developing country, especially in Pakistan’s circumstances, can afford to go down the short-termist path that it seems to have chosen in recent years.

The monetary policy thus pinpoints the unhealthy trends that have brought Pakistan once again to the stage it was in at the end of 1998 in terms of internal and external imbalances. The shift of emphasis from consumption to saving is evident throughout the policy statement. That is why it emphasizes the measures SBP plans to control aggregate demand, and following this policy, restore both internal and external imbalances.

SBP’s commitment to tighten liquidity now sounds credible since increase in statutory reserve requirements and the discount rate, and a firm advice to ensure the use of borrowed funds precisely for the purposes agreed with lending banks (all preceding the monetary policy announcement) manifest a resolve to drain liquidity from the market on a continuing basis and not allow it to feed into the already high inflationary trend in the non-food items.

With these measures in place, and its resolve to conduct frequent OMOs, SBP may cut down private sector credit growth to 18.4 per cent from its level of 23.5 per cent in FY 06. However, what remains to be seen is the extent to which the government can act on SBP advice because rapidly changing international market scene points to a gradual slowdown with pressures eventually building on governments all round for living with higher fiscal deficits in order to alleviate the sufferings of their people.

According to the policy’s own admission, “while short-term growth outlook is still intact, there is clearly a risk that global growth could slowdown in future as a result of rise in inflationary pressures .…….. and generate additional pressure on open economies like Pakistan that are not only significantly dependent on those economies for trade and investment, but also import a substantial portion of its energy requirements”. While the expectation about short-term growth outlook being intact is over optimistic, the long-term view about economic slowdown is not.

Expectations about the future bring us back to square one i.e. need for policy co-ordination. The developing scenario requires, firstly, re-examining our trade policy, especially with reference to import of items with marginal utility or those for which locally produced substitutes are available and, secondly, for augmenting the export sector (at the moment with appropriate price support and, in the long-term, with non-price support mechanisms).

Thirdly, the government must re-assess its borrowing strategy. Its policy to borrow short-term when interest rates were low, was wrong. Persisting with that policy, it will end up wiping out the economies it achieved in debt servicing cost because gradually but surely interest rates will rise.

Finally, excessive borrowing from the central bank (and also preventing full monetisation of the debt) was bad, and must be avoided in the larger interests of the economy.

Banking sector, which isn’t heeding SBP advice, poses a far bigger challenge. Response to the last T-Bill auction (August 2) conveyed this impression. Against a target of Rs38 billion, banks offered only Rs25 billion but SBP could borrow only Rs12.75 billion without upping the yield thereon (and therefore the overall interest rates) too much.

Banks have neither raised deposit profit rates nor narrowed loan spreads nor cut consumer lending to recoup funds for investment in public and private sectors.

Hopefully, banks aren’t testing the central bank’s resolve. Should that be so, it will reflect a desire for benefiting at the expense of everything else including productive deployment of the nation’s savings, economic self-sufficiency and stability and, above all, a sense of social responsibility.

The current account deficit to-date reflects just that. Hopefully, banks realise their role in this state of affairs, and will not make things worse than they already are.