A FEW years ago, while in conversation with one of the country’s leading businessmen, I was taken aback by something he said.
“I know how the fiscal deficit can be brought down by Rs200bn without imposing a single tax on anyone,” he said.
Then he pulled out a piece of paper, grabbed a pen, and showed how the basket of goods that is used to calculate the Consumer Price Index (CPI) carries far greater weight for food than the CPI does in other countries, notably India.
With rapid strokes of the pen, he drew diagrams and arrows and flow charts with numbers to show that if we recalibrate the CPI basket, reduce the weight of food items, we could bring inflation down to single digits.
“Once inflation is brought down, the case for bringing down interest rates becomes easy,” he went on, revealing his hand. “Each percentage point reduction of the policy discount rate saves us Rs50bn in debt servicing cost from the budget. Building the case for a four percentage point reduction in the discount rate becomes easy, and you have savings of Rs200bn in one year alone!”
I wish I had saved that piece of paper on which he had scribbled his entire reasoning because only about six months later the CPI basket was indeed recalibrated, and the weight given to food items was reduced, and the government proclaimed victory in the fight against inflation, and interest rates were slashed.
The businessman in question, no small fry I assure you, is known for his close links to the man on the hill. He’s also part of a small but very influential segment of the business community that has heavily invested in real estate projects. And to their misfortune, this segment acquired its stakes in real estate at or near the peak of the property bubble of the late Musharraf years.
When the Musharraf-era property bubble burst in 2008, this segment of business leaders found themselves squeezed by the collapsing prices of their property on the one hand, and the skyrocketing costs of debt servicing on the other as interest rates rose to bring runaway inflation back under control.
Ever since they’ve been waging a war of attrition against the cycle of monetary tightening that began in earnest under the governorship of Shamshad Akhtar, and ended in earnest only last year with the aggressive and historic rate cut of 150 basis points, followed up again this year in August.
Meanwhile, the government has been desperately searching for fiscal space ever since the NFC award went into effect in summer 2010.
Squeezed between the growing transfers to the provinces, adding up to 77 per cent of the divisible pool last fiscal, and the spending requirements of an election cycle, the government has been in a frenzied search for more revenue in the last one year, and the intensity of that search is only increasing.
The ferocity with which the government has been borrowing since July shows this desperation, and the State Bank makes reference to it in the Monetary Policy Decision document, saying that liquidity injections into the banking system increased to Rs611bn in only three months!
All the while a group within the State Bank has been repeatedly voicing concern at the behaviour of the banks and their refusal to extend credit to the private sector, saying they are “finding it easy to avoid the private sector by lending to the government without any risk” in the words of the Monetary Policy Decision.
This group argues for the hope that as interest rates are further reduced, “scheduled banks will have to step up efforts to go back to their basic intermediary role and channel loan-able funds to the private sector.”
Yet the very next paragraph gives us a hint of the divided opinion within the State Bank. “The other critical, and probably more fundamental, factor holding back off-take in the private sector credit,” the Decision announces, “is the consistent shortage of energy.” Fair enough, except that this is the precise reason given by bankers for their reluctance to lend to the private sector.
Clearly these two paragraphs are making incompatible points regarding the role monetary policy has to play in encouraging credit to the private sector.
In one place the State Bank tells us that the banks are reluctant to lend to the private sector because “lending to the government without any risk” is easier, and in the next line we’re told the “more fundamental” reason is in fact “the consistent shortage of energy” that constantly hampers private sector fortunes, and impacts its debt-servicing capacity.
If the former statement is true, then the scheduled banks can theoretically be dislodged from their laziness and forced to take on risk and lend to the private sector like they’re supposed to simply by lowering the returns they get on government debt.
But if the latter statement is true, then squeezing the banks will not do any good because they simply don’t have many options in the private sector to begin with.
The incompatibility of these statements, and the assumptions and assessments that lie behind them, is the clearest indication that staff opinion within the bank is divided on the direction of monetary policy, and this division is finding its way into the bank’s pronouncements.
It was there to see in August when the announcement said one thing and the Decision another. It’s here again, when in the same document the State Bank has two different takes on the determinants of bank-lending behaviour.
An unlikely confluence of interests has gone into the interest rate cuts that the State Bank has been haphazardly applying since last year. A revenue hungry government, egged on by heavily indebted business groups has managed to weigh in on a divided State Bank to cut interest rates.
The only losers in the gambit appear to be the banks, and who cares about them anyway?
The writer is a Karachi-based journalist covering business and economic policy.