THE first quarter of the current fiscal year has ended with a below 3 per cent consumer inflation, leaving space for the State Bank to further ease off the monetary policy.

Though the economic managers have not so far indicated if the SBP will do it but one thing is clear: a trade-off between several conflicting aspects of easing monetary policy has become a bit easier. Before September 11, the economic managers were concerned about how to keep exchange rates from de-stabilising if they go for further easing off of the monetary policy.

Now that is not much of a concern. The rupee has so far appreciated by more than 3 per cent against the US dollar in the inter-bank market. In the open market also, it has gained no less than 6 per cent of additional value since September 11 when terrorists slammed the hijacked planes into the twin towers of the World Trade Centre.

More important is the point that inflation at below 3 per cent at the end of the first quarter is less likely to shoot up in the second quarter if the monetary policy remains intact. The recent cut in oil prices could even lower inflation in this quarter. Non-food inflation stood at 5 per cent at the end of the first quarter. There is a feeling in the oil industry that world oil prices may further decline. If that happens and local oil prices fall again then inflation should remain more or less unchanged - i.e. if the monetary policy is not eased off. In other words, if Pakistan ceases off its monetary policy in this quarter, the consequent rise in inflation should be nominal. Since the rupee is much stronger than it was at the start of the fiscal year, the easing off of the monetary policy on the exchange rate should also be manageable.

The future health of the rupee depends much on how badly the economy is hit by the consequences of the September 11 terrorist attacks on New York and Washington - and the US retaliatory air strikes on Afghanistan.

The Commerce Minister, Razzak Dawood, has said that the country could lose at least $1.4 billion in export earnings alone. The entire financial fall-out could be much larger.

The exchange rate stability also depends on how much financial relief Islamabad gets from the US and other countries for supporting their was against terrorism and how much debt it can raise from the IMF and the World Bank.

The amount of money that the US and other countries have so far promised to give Pakistan in aids and grants for supporting the US-led attack on Kabul is less than $100 million. Regardless of how soon this amount comes in Pakistan, the size of the package itself is very small. So there is not much point in pinning hopes on this, when it comes to keeping the exchange rate stable.

But there is a silver lining on the sky. Pakistan can negotiate a sizable three-year poverty and reduction growth facility with the IMF and the World Bank. Pakistan’s decision to support the US-led war against Kabul has made it possible for its economic managers to press for sizable funds from the IFIs.

Though Pakistan has already got loans rescheduled from bilateral creditors, including the US part of its external debt falling due for payment during this fiscal year. But a PRGF of at least $2.5 billion is still crucial for Islamabad to remain current on its external debt payments.

The crux of the problem lies here. If Pakistan gets PRGF - and if it were not tagged with very tough conditions - then the country would not find it difficult to move from economic stablization to growth programme. In that event the scope of easing monetary policy becomes brighter. But if PRGF negotiations linger on, or if its preconditions are demanding then it would be difficult to ease of the monetary policy without destablizing the exchange rates. The negotiations for PRGF are underway but there is no official word available about its size and structure, and on how soon Pakistan is going to get it.

The IMF has so far shown reluctance in offering a PRGF of $2.5 billion. In fact one of its senior officials has already ruled out this possibility while speaking at a press conference in Washington earlier this month.

The Fund seems more interested in offering a mix of low-priced PRGF and expensive EFF (Extended Fund Facility). Pakistanis not only trying to persuade the Fund officials that it cannot afford EFF that carries a high interest rate of 6.5 per cent and is trying its level best to secure as much as possible under PRGF. President Pervez Musharraf and Finance Minister Shaukat Aziz made it a point during his meetings last week with the visiting US Secretary of State Colin Powell and the UK Secretary of State for International Development Claire Short. It is yet to be seen if their governments that are major share- holders would be able to persuade the Fund to accept Pakistan’s request for a sizable soft-term PRGF.

The Fund’s insistence on providing a mix of PRGF to Pakistan is very much disturbing also because EFF is a medium-term stablization package. Pakistan has already been through a 10-month $96 million IMF standby arrangement tagged with harsh conditions unfavourable to economic growth.

Many independent economists have said that the IMF conditions were more to blame for Pakistan’s below 3 per cent economic growth in 2000-01 than the drought.

So if the PRGF were going to be accompanied by EFF, or if PRGF itself were to be tagged with growth-choking conditions then there would not be enough fiscal space available for easing off of the monetary policy.

But Pakistan’s below 3 per cent growth against the target of 4.5 per cent in 2000-01, and the current US-led world recession call for kick-starting the economy by easing the monetary policy. The State Bank does realize this. It has already eased off the monetary policy to some extent by lowering its discount rate from 14 to 12 per cent so far during this fiscal year. But whether it goes for further easing or not depends on many things - some of which have been discussed here. One important point is that the SBP wants to make sure that the lowering of the discount rate achieves its aim i.e. reduction in lending rates making increased funds available for investment and cutting down the financial cost of the existing businesses.

Despite two per cent cut in the SBP discount rates in July-August banks’ lending rates have yet not fallen. The average lending rate of all banks combined rather inreased from 13.74 per cent at the end of June to 14.07 per cent at the end of August, showing a rise of 33 basis points. Figures for September are not available, but senior bankers say most banks have not made an aggressive cut in lending rates last month.

It is true that commercial lending rates respond to changes in the SBP discount rate with a time lag. But had the banks been able to cut their lending rates significantly before October it would have had enabled the private sector to make aggressive borrowing during this quarter. Private sector credit demand picks up in October and continues through March as agricultural output is in full swing during these months.