December 03, 2006	Sunday	Ziqa'ad 11, 1427

KARACHI, Dec 2: The State Bank has warned the government not to follow expansionary fiscal policy as it has further compounded risks to the economy in 2007.

The State Bank annual report for 2005-06 issued on Saturday cautioned the government about the prevailing tendencies of borrowing heavily from the State Bank while maintaining deficit as high as 4.2 per cent.

“On the one hand, it adds to inflationary pressures by stimulating demand, and on the other hand, government’s higher funding requirements induce more pressures to raise interest rates to curb incremental pressures on the economy,” said the report.

The fiscal deficit was not only higher in FY06 at 4.2 per cent relative to 3.3 per cent of GDP in FY05 but a significant part of the larger deficit was monetised through borrowings from the central bank.

“Both tendencies prevail in FY07, as evident from the first quarter trend, and need to be curtailed,” said the report.

The government needs to diversify sources of borrowings and adopt a judicious mix of short-term and long-term borrowings, the report suggested again.

“During FY06, the government relied heavily on borrowings from the central bank, and effectively ignored non-bank borrowings,” the report said.

The stock of long-term tradable bonds -– PIBs and FIBs -- alone fell by Rs23 billion during the year, and the stock of long-term National Savings Schemes (NSS) instruments also declined. The SBP expressed serious concern over the use of NSS for government borrowing.

“Financial reforms aimed at eradicating financial repression have suffered a setback as a result of this decision,” said the SBP report.

The report revealed that all major sectors of the economy registered a slowdown in credit offtake during 2005-06, suggesting a fall in aggregate demand due to a tightening of monetary policy.

The apparent slowdown of credit offtake in the agriculture sector is simply a reflection of loan write-offs by ZTBL. Specifically, ZTBL wrote off loans amounting to over Rs22 billion during FY06.

Within the manufacturing sector, the frequency distribution curve shows that credit growth in a large number of industries has slowed down significantly during FY06.

In addition to the impact of base effect and pricing effect, the slowdown is attributed to a number of industry specific factors. For instance, the slowdown in textile industry stemmed mainly from the decline in production of synthetic textiles on account of heavy imports.

The deceleration in credit growth to construction industry is perhaps reflective of a relative decline in building material prices in FY06. Decomposing the construction sector credit, the credit for building projects registered a slowdown while credit for infrastructure projects registered an increase during FY06.

The slowdown in growth of credit to the telecommunication sector was caused by absence of one-time fixed investment loans during FY05 by a new cellular company to start operations in Pakistan.

After a lackluster showing during FY05, trade related loans registered sharp growth during FY06, primarily due to an increase in foreign currency loans. Specifically, the foreign currency loans registered a sharp increase of Rs42.2 billion compared with net retirements of Rs20 billion in the preceding year.

The State Bank said the debt-to-GDP ratio reached 60 per cent. This was the target for 2013 but achieved in 2006 which is a source of comfort under the high credit demands. This is the fifth successive year that the debt-to-GDP ratio has improved and this is the first time in more than two decades that the ratio has fallen below 60 per cent.

The State Bank report ruled out any sharp increase in the interest rate or rupee devaluation.

“On the one hand, given the prevailing tight monetary policy, a further sharp rise in interest rates could risk considerably slowing the growth momentum of the economy, and on the other hand, sharp rupee depreciation could lead to self-fulfilling expectations that could destabilise the economy.”

The report said that despite a sharp deceleration, monetary growth during FY06 was amongst the highest in the last 15 years, relative to the growth in nominal GDP.