The Annual Report of the State Bank of Pakistan for FY02 is disappointing on all major counts, viz. understanding and analysis of (i) macroeconomic developments, (ii) monetary and credit policy, and (iii) development of the financial sector.

Macroeconomic developments: a) “The tremendous improvement in Pakistan’s external sector contributed to positive developments for many macroeconomic indicators during the year.” (AR p.1)

i) The external sector did register tremendous improvement during FY02 but, as the report itself pointed out, that was attributable entirely to the impact of exogenous factors. However, the claim that it contributed to positive developments for many macroeconomic indicators is not supported by facts.

ii) Investment registered substantial decline during FY02:

As percent of GNP (market price)

FY01 FY02

Gross Total Investment 16.2 13.8

Gross Fixed Investment 14.5 12.2

(Public Sector) (6.4) (4.7)

(Private Sector) (8.1) (7.5)

iii) Savings also posted significant decline during FY02:

National Savings 15.3 13.85

Of which: (Private Savings) (14.3) (12.6)

Foreign Savings (Net Inflow) 0.9 - 0.06

iv) The foreign sector had no role in improvement in the growth rate of commodity producing sector of the economy from 0.2 in FY01 to 2.12 in FY02. Anyhow it fell short of increase in population.

v) The overall budget deficit increased from 5.3 per cent of GDP(MP) in FY01 to 6.6 per cent in FY02.

b) The claim that “inflation was down to 3.5 per cent as the appreciating Rupee lowered the cost of imported inputs” (AR p.1) is misleading and unwarranted, to say the least. Its impact on the price level, if any, would be insignificant. Moreover, the enterprises rarely pass on the benefit of lower costs to the consumers in the form of price reduction.

c) “The lower food inflation reflects overall macroeconomic policy to protect the lower earning groups compared with the well-to-do from inflation through ensuring availability of essential food items during FY02” (AR p.56). Firstly, “ensuring availability of essential food items” does not constitute part of macroeconomic policy. Secondly, the report does not mention these measures.

d) “While the growth in national savings in FY01 was entirely indigenous, coming from the households and public sector (other than general government), the growth in FY02 was the outcome of increased net factor income from abroad through higher remittances.” (AR p.35). This shows that the SBP authorities are innocent of even elementary knowledge of macroeconomic concepts. National savings were “entirely indigenous” both in FY01 and FY02; in both years national savings comprised private and public savings. National savings are adjusted with net factor income from abroad to arrive at domestic savings. (See table 2.22 on p.35)

e) “It is interesting that despite a decline in the savings ratio, national savings were still able to meet the gross investment requirements of the country. By contrast, in FY01, national savings financed only 94.5 per cent of the total investments and foreign savings, i.e. net external resource inflows, funded the remaining investments. As a result, the saving-investment gap turned into a positive 0.1 per cent of GNP in FY02 from a negative 0.9 per cent in FY01, showing an overall improvement of about 1.0 per cent of GNP.” (AR p.35)

This is a masterpiece of confused thinking. It will be seen that this is not the only indicator of SBP authorities being thoroughly confused. It is not correct to suggest that national savings, despite being lower, “were still able to meet the gross investment requirements of the country.” According to this logic if, as a percent of GNP, total investment falls to 2 per cent and national savings to 4 per cent, and outflow of resources increases to 2 per cent during FY03, then this would be an improvement upon economic performance during FY02. The figure 2.23 suggests that economic performance during FY02 when, as a percent of GNP, total investment at 13.8 per cent was financed entirely by national savings, was superior to that of FY92 when total investment at 19.9 per cent was partly financed by national savings at 16.9 per cent and partly by net external resource inflow at 3 per cent, while real GDP rose by 7.7 per cent in FY92 as against 3.6 per cent during FY02.

It is, of course, preferable to achieve sustained high level of investment based on national savings but, owing to low level of national savings, foreign investment is desirable in developing countries till they reach the take-off stage. One must never forget that larger the saving and investment effort, larger the growth rate of the economy, and vice-versa. The functional relationship between sustained high level of investment and growth rate of the economy is evident from the performance of China, Korea, Malaysia and India.

B: Price trends: The rate of inflation in terms of CPI came down to 3.5 per cent in FY02 from 4.4 per cent last year. This was attributable to (i) “better availability of essential commodities due to improved production of both food and non-food items”, (ii) “a noticeable deceleration in the net domestic assets of SBP helped absorbing a significant increase in its net foreign assets that enabled the reserve money to expand at a much lower pace than that of money supply, thereby supporting the deceleration in inflation”; and (iii) “appreciation of Pak Rupee by 6.7 per cent during FY02 also helped control the imported component of inflation.”

The three factors mentioned above do not explain deceleration of price inflation during FY02. There was not much improvement in availabilities. The production of major agricultural crops declined for the second year in succession, while growth rate of industrial production slowed down from 7.6 per cent in FY01 to 4.4 per cent in FY02. Over and above, the growth rate of commodity producing sector fell short of increase in population. The 14.8 per cent rise in monetary assets as against GDP growth of 3.6 per cent is not an argument for deceleration in inflation. The impact of third factor, as discussed above, is likely to be insignificant.

The increase in scheduled banks time deposits accounted for 51.6 per cent of expansion in monetary assets during FY02. This was attributable primarily to sharp rise in home remittances. It appears that people were holding on to their savings and, as a result, there was smaller pressure on demand in the goods market. Secondly, a big chunk of money was circulating within the financial markets, including foreign exchange market, thereby reducing demand pressure in the goods market. No wonder, “FY02 was a relatively good year for the Karachi stock market, with the benchmark the KSE 100 index recording a 29.5 per cent rise in sharp contrast to the 10.1 per cent drop witnessed during the preceding fiscal year.” (AR p.119) The increasing diversion of money to speculative activities in foreign exchange and stock markets reduced demand pressure in the goods market.

C: Credit policy: Monetary assets increased by 14.8 per cent during FY02. Of the total increase of Rs225.8 billion in monetary assets, Rs206.2 billion was accounted for by increase in net foreign assets of the banking system, and only Rs19.7 billion by domestic credit expansion. The ratio of currency in circulation to monetary assets edged up from 24.6 per cent in June, 01 to 24.8 per cent in June, 02.

The above data indicate that monetary policy has become captive to developments in foreign exchange market. The discount rate was reduced from 14 to 13 per cent in July, to 12 per cent in August, to 10 per cent in October, 01, and to 9 per cent in January, 02. However, this sharp decline in interest rate failed to stimulate private sector demand for bank credit. “The absence of further rate cuts during FY02 simply reflects (1) the end of the seasonal credit off-take period, (2) a significant drop in the weighted average lending rate, and (3) the concerns that an excessive reduction in interest rates over too short a period could destabilize the financial system.” (AR 9.79)

Banks are the largest mobilizers of savings in the economy. Although overall level of savings and investment is on the decline, banks are being encouraged to channel savings placed with them towards consumer financing. “The last couple of years have witnessed tremendous growth in consumer financing.” (AR p.29). The objective is to boost domestic production of cars, refrigerators and other durable consumer goods by stepping up their demand through provision of credit facilities for their purchase. The increasing use of credit cards and extension of credit to dealers in stocks, securities and debentures are other channels for misuse of resources placed at the disposal of banks.

D: Financial system: The privatization of nationalized banks and non-banking financial institutions(NBFIs) involves socialization of losses incurred by them. These financial institutions needed restructuring to make them manageable and profitable with a view to attracting investors. For this purpose, huge amount of funds was borrowed from IFIs to lay off superfluous staff. Moreover, bad debts amounting to billions of rupees were to be replaced with fresh government securities whose interest payments would amount to billions of rupees. This burden on masses in the form of higher taxes and increase in prices of utilities is likely to reduce them to sub-human subsistence.

The ABL and MCB were privatized earlier and UBL recently, while 14 new domestic private banks were incorporated to ensure greater competition among banks. Now it is held that small private commercial banks are too weak and they need to be merged into fewer but stronger institutions.

Sixteen investment banks, three discount houses, two stock exchanges, three housing finance companies, 32 leasing companies and 50 modarabas were set up during 90s at a considerable cost in terms of manpower and material resources to impart breadth and depth to the financial sector. Now it is held that proliferation of financial institutions has resulted in fragmentation of the financial sector and these need to be reorganized in a manner that a single NBFC would provide all non-banking services.

The foregoing would lead one to conclude that the restructuring of the financial sector pursued during the last decade was not well-conceived and that the monetary authorities are being forced by the pressure of circumstances to take a U-turn.

(The writer is former Economic Adviser of the State Bank of Pakistan.)