KARACHI, Jan 1: The State Bank’s first quarter report 2002-03 spells out policy shift that, in some respects, has set new directions for the economy.

Helped by a marked improvement in the external sector, the focus is now turning on the needs to pass on the benefits of an appreciating rupee to the broader economy, as opposed to the continuous devaluation to boost exports.

A stronger rupee has already paid dividends in the form of a lower cost of external debt and cheaper import inputs, says the SBP report and adds that the gain could become increasingly visible in coming years, particularly if domestic energy and transportation costs can be contained by the lower rupee cost of imported oil.

And SBP officials assert that lower fiscal deficit had reduced the financial costs of the economy, as interest rates have weakened and there has been a sharp fall in government borrowings for budgetary support.

As it would appear from the SBP report a declining interest rate and a strong rupee would help reduce debt costs and servicing that tops all claims on the annual federal budget. It is supplementing government efforts to reduce debts to sustainable level.

Anticipating continued multilateral assistance, increased home remittances and further improvement in capital flows, the State Bank would continue to support “a gradual appreciation of the rupee”. The rupee appreciated by 8.3 per cent during October 2001-September 2002 and by 1.5 per cent in first quarter of current fiscal.

As the rupee gains against hard currencies, exports are being encouraged by falling interest rates and non-inflationary stimulus to the economy. A stable rupee keeps the cost of imported plants, machinery and spare parts cheaper and also curbs imported inflation. The continuing strength of the rupee is also reducing cost of investment and inputs for import-based industries like pharmaceuticals and automobiles. It may be recalled that it was massive devaluation of the national currency in early 1970s that turned many industries sick because of huge financial charges.

Once bitten twice shy, some textile mill owners have recently resorted to more of self-reliance and less of borrowing to modernize their plants.

Besides, quite a few of the large textile groups claim that there are borrowing at low rates from the financial markets than offered by the local banks to finance their exports. With the rupee gaining strength, the imports of machinery is picking up. The SBP report says that the import growth in the first quarter 2003 was largely driven by higher machinery imports. “Machinery imports staged an impressive upturn, recording a $158.3 million increase (33 per cent) over the corresponding period of last year. The State Bank says that this development suggests “a revival of business confidence.”

A variety of factors including unprecedented foreign exchange reserves have also helped to eliminate the speculative attack to weaken the rupee. One explanation is that flight of capital has been contained due to increased scrutiny of international fund flows. Yet another view is that there is a “reverse flight” of capital. It may also be the reason for meteoric rise of the stock market, increase in real estate prices in posh localities and higher sales of consumer durables.

Although the State Bank is silent on the future of the US dollar, currency experts feel that given the volume of American trade gap and budget deficit combined with declining foreign investment that made current account deficits sustainable, the greenback would be allowed by US policy makers to depreciate for another year or two help stage economy recovery. Since bulk of the foreign trade transactions by Pakistan are being conducted in dollar, it helps keep the rupee stable and strong.

As the country is moving from a regulated economy to emerging market to face competition, the exchange and interest rates have assumed much greater significance in boosting domestic private investment and economic growth.

The outcome of three years’ reforms, the SBP report adds leads to two important conclusions: a) a focus on macroeconomics discipline pays dividends for the economy; b) the continuation of fiscal discipline and economic reforms do not necessarily represent a trade-off with economic growth. The central bank wants to bring budget deficits to more sustainable levels.

“We should implement the next phase of reforms where development expenditures on infrastructure, education, health, water and sewerage, Khushhali programmes in the districts, irrigation, where storage and conservation can be enhanced without fear of breaking fiscal targets, advised the central bank.

In the past fiscal targets were met by raising revenues and slashing development spending. With the growing fiscal space, also helped by a stronger rupee and lower interest rates, an increased public sector spending is being sustained. In the first quarter of 2003, the development expenditure has witnessed an impressive increase of Rs8.2 billion to touch Rs21.7 billion.

The SBP report says the growth in expenditure was contained well below the revenue growth rate, holding down the budgetary deficit for the period. About half of the increase in spending was for development. A lower budgetary deficit of Rs41 billion was financed by external and domestic non-bank borrowings.

The State Bank now says that increased public sector investment and higher private sector credit to these labour-intensive sectors, and not budgetary subsidies, are the key to revival of growth, employment and poverty reduction.