KARACHI, July 7: The State Bank on Monday said its monetary policy was unlikely to change over the next six months due to low inflation and strong economic fundamentals.
“The country’s current stance is unlikely to be altered unless there is a material shift in the inflation outlook or exogenous shocks hit the economy,” the State Bank of Pakistan said in its first monetary policy statement for fiscal 2003/04.
Pakistan has been gradually loosening its monetary policy since July 2001. The central bank last cut its discount rate to 7.5 per cent from 9 per cent in November.
The bank said its monetary policy was designed to ensure stable exchange rates, unrestricted foreign exchange inflows and stable and low interest rates.—Reuters
Following is the text of monetary policy statement:
The global economy continued to show weakness and the recovery hasn’t yet materialized. It is most unlikely that the recovery will take place by the end of this year. Despite sluggish world growth and high risk of deflation, Pakistan’s economy’s performance in FY 2002-03 was better than expected.
The actual GDP growth turned out to be 5.1 per cent compared to the target and projected rate of 4.5 per cent. The growth was broad based and uniformly spread across the three major sectors - agriculture, manufacturing and services. Higher major food crops output added to supplies and do not pose any serious concern despite lower than expected wheat crop. Imported inflation remained subdued due to lower world prices of petroleum products and raw materials and a gradual appreciation of rupee exchange rate. Broad money supply expanded in excess of the target but as it was caused by autonomous capital flows from Pakistani workers abroad did not affect inflationary expectations.
The outlook for the next six months remains robust. GDP growth is projected at 5.3 per cent with inflation below 4 per cent. Low interest rate environment and depressed demand for credit by government and public sector will crowd-in private sector credit demand — both by the corporate as well as consumer sectors. The banks are beginning to move into new areas of business such as housing, SMEs, consumer durable and agriculture. Thus, higher demand for funds by the private sector and instead public sector development spending will help meet the postulated targets for domestic economy. External demand may not be that strong as it was during FY03 but is expected to remain fairly buoyant. Inflationary expectations are unlikely to exert any upward pressure due to pro-active monetary management, fiscal discipline, adequate supply situation and stable exchange rate. Continuous assessment of the growth prospects and inflation will trigger the required policy response.
To summarize, the positive factors likely to keep inflation under control are:
a) global recession and risk of deflation in the US, Europe and Japan b) appreciation of rupee vis-a-vis US dollar c) low international prices of imported goods and commodities d) availability of adequate food supplies e) stable petroleum prices f) no sharp increases in utility prices g) lower fiscal deficit h) low cost of domestic capital that reduces financial charges of business i) no pressure on wage rates as unemployment rates have risen j) lower credit demand of public enterprises and autonomous bodies (e.g. early retirement of loans by Pak Steel)
The negative factors impinging upon the inflationary outlook are:
a) above average growth of reserve money b) high growth of broad money in excess of nominal GDP growth c) hike in asset prices d) exceptional growth in private sector credit e) upsurge in households’ net debt position due to consumer loan f) increase in public servants’ wages and salaries.
As the positive factors outweigh the negative ones, the balance of risks still remains titled in favour of the continuation of existing monetary policy stance unless other unanticipated exogenous shocks disturb the balance.
The balance of risks, as they are assessed today does not necessitate any major shift in the monetary policy stance for the next six months. In the current environment of slow pick-up in economic growth and gradual build up of financial product innovations it is unlikely that excess liquidity will translate into inflationary pressure. Although the growth of loans to the private sector has accelerated, it is still only moderately higher than the rate of output growth in current prices. SBP will, therefore, continue with the present policies, aimed at keeping the policy interest rate unchanged to provide a non-inflationary stimulus to the private sector and contain inflation. The intervention by the central bank in the inter-bank foreign exchange market will be timed to smooth the volatility, curb speculation and maintain a stable exchange rate in consonance with the competitiveness of Pakistan’s export.
The central bank’s challenge will be to strike a balance between uninterrupted foreign exchange inflows, stable exchange rate and lower real interest rate.
Capital inflows on account of workers’ remittances are likely to slow down to $3.6 billion. The government is also planning to accelerate payments and pre-payments of external debt and liabilities in the FY 04. Thus reserve money growth is likely to remain within the target with pressures for sterilization easing off a little bit.
The risks associated with the above scenario are mainly at present external, political and non-economic. Continued recession in the global economy will affect Pakistan’s external demand and export earnings. Non-resolution of the political issues facing the Parliament and disturbances in security situation may delay investor response to the opportunities afforded by macroeconomic environment. Slow-down in workers’ remittances will obviate the need for sterilization. Unless the inflationary expectations are reversed or some unanticipated exogenous shocks hit the economy the present stance of monetary policy will remain unchanged.
Monetary and Credit Trends (July 2002-June 14, 2003)
Substantial capital flows continued to pour in and resulted in considerable monetary expansion of 16.4 per cent (Rs289.3 billion) between July 2002 and June 14, 2003 against a revised monetary expansion target of 16 per cent and monetary expansion of Rs212.8 billion or 14 per cent in the corresponding period of last year. Net foreign assets (NFA) of the banking system which were the sole contributor to the entire monetary growth, expanded by 128.1 per cent (Rs300.5 billion) while net domestic assets (NDA) of the banking system showed a contraction of 0.73 per cent (-Rs 11.2 billion). Principal inflows that expanded the stock of the NFA included huge workers’ remittances ($3.88 billion), FDI inflows ($0.74 billion), and programme aid from IFIs. The stock of NDA showed depletion in spite of record-high credit off-take by the private sector.
Foreign exchange reserves continued to build up due to sustained rise in workers’ remittances, and other inflows, and increased by 66.8 per cent to $10.726 billion (equivalent to roughly one-year imports bill) between July 2002 and June 2003. These reserves would contribute a long way towards restoring investors confidence, improving the country’s credit rating and attracting foreign investment.
SBP continued with its policy of sterilization to contain the growth of reserve money (RM) resulting from foreign exchange purchases. SBP’s total purchases up to June 14, 2003 increased by 24.8 per cent to $4.81 billion (equivalent to injection of Rs282 billion). If the monetary impact of these purchases had not been partially sterilized the actual reserve money growth would have been around 48.2 per cent instead of 19.7 per cent, and monetary expansion would have been around 44.1 per cent instead of 16.4 per cent. SBP’s dynamic presence in the foreign exchange market confined appreciation of rupee-dollar parity to moderate levels as rupee appreciated to the extent of 3.9 per cent between July 2002 and June 2003 compared with appreciation of 6.8 per cent in the corresponding period of last year. The appreciation of rupee-$ parity did not adversely impact the export market because the real effective exchange rate index (a broader measure of trade competitiveness) showed a small appreciation of rupee (against a basket of 20 currencies) to the extent of 1.4 per cent between July 2002 and June 2003.
It is for the first time under the market-based mechanism of interest rate determination that interest rates have dipped so low and this seems to have thrilled the private sector community as its net credit off-take this year has touched a record peak of Rs138.6 billion. Another factor that has induced the private sector to avail more bank credit is the availability of more innovative products (e.g. consumer loans) offered by the banking system.
Bank credit to the private sector between July 2002 and June 14, 2003 expanded by 17.3 per cent (Rs138.6 billion) compared to the expansion of 4.5 per cent (Rs33.8 billion) in the corresponding period of last year. However, net disbursements during July 2002-June 14, 2003 in relation to net disbursements compared with the same period of last year, shot up by 309 per cent.
The most notable credit development that has taken place this year is the pick-up in the private sector credit off-take even beyond the third quarter of the fiscal year, which is usually a retirement season. Clearly, this supports the view that consumer confidence is rising and financial conditions are supportive of growth in investment and spending. Lower lending rates caused by easy monetary policy coupled with improvement in the macroeconomic fundamentals resulted in increased economic activity and hence escalated the demand for private sector credit. In view of recent liquidity and interest rate trends and given the fact that banks are offering more consumer products, one should expect the private sector credit off-take to be exceptional even in 2003-04.
The government also benefited profusely from the low interest rate environment, as it was able to reduce substantially its cost of funding from both the bank and non-bank sources. The strategy of the government was to retire its expensive bank credit and also shift its borrowings away from SBP to the scheduled banks. This permitted SBP to off-load its claims on government to the rest of the financial system and therefore reinforced the process of sterilization. Government’s net bank borrowings showed a net retirement of Rs70.7 billion during July 2002-June 14, 2003 compared with net bank borrowings of Rs18.5 b billion in the corresponding period of last year.
In short, liquidity conditions are expected to be at ease even during 2003-04 owing primarily to workers’ remittances, which are projected at $3.6 billion. Taking into consideration the continued forex inflows, GDP growth target of 5.3 per cent and inflation target of 4 per cent, monetary expansion for 2003-04 is projected at 11 per cent (Rs230 billion). It will be contributed by expansion in NFA (Rs130 billion) and NDA of the banking system (Rs100 billion).
Inflation Trends
CPI Inflation continued to decelerate and remained under the current-year target of 4 per cent despite a massive monetary expansion of 16.4 per cent during the year up to June 14, 2003. The inflationary tendencies remained in check on account of stable and appreciating rupee-dollar parity and better food supplies. CPI inflation stood lower at 3.21 per cent during July 02-May 03 compared with 3.46 per cent in the same period last year. The non-food component of CPI basket witnessed a notable price increase between July 2002 and May 2003 but this was neutralized by declines in the prices of food-component of the basket between the same period.
The price index of non-food items showed a rising trend this year primarily due to steady rise in the prices of POL products and eventually rising transportation cost. However, average food prices this year came down despite rising prices of whet, flour, rice and edible oil.
CPI inflation is expected to remain low and stable at 4 per cent during 2003-04. The on-going sterilization and strong rupee together with sufficient supply of food would definitely contain inflationary pressures and make it possible to achieve the target.
Interest Rate Environment
The cost of bank credit has significantly come down in recent times due to high bank liquidity and downward trend of lending rates triggered by the low discount rate. Banking spread (average lending rate minus average deposit rate) has shrunk by 437 basis points form July 2001 and by 315 basis points from July 2002 to 4.11 per cent in May 2003. The private sector is much better placed now as the overall weighted average lending rate of all banks has dipped to 7.09 per cent in May 2003 from 12.17 per cent in July 2002 and 14.49 per cent in July 2001. Export re- finance rate (charged by banks) has also come down by 450 basis points to 3.5 per cent from 8 per cent in July 2002. In view of the excess liquidity and low inflation, the lending rates are expected to come down further. Similarly the borrowing cost to the government has also diminished to new lows. Yield on benchmark, 6-month T-bills has plummeted to 1.67 per cent from an average of 6.5 per cent since July 2002. Likewise, yields on 3- month and 12-month T-bills have also drastically declined to 1.66 percent and 2.37 per cent from 5.81 per cent and 6.99 per cent, respectively since July 2002.
Returns on various national savings schemes have also shown declines of different magnitudes, and this has greatly benefited the government to lower its cost of non-bank borrowings. The lower cost of borrowing has provided government with some leeway to allocate more funds for developmental purposes particularly for education and health.
Low interest rate environment, which is expected to persist, should not only dampen the inflationary expectations but also scale up investment activities necessary to achieve the GDP growth target of 5.3 per cent for 2003-04. However, SBP would need to continue to sterilize the monetary impact of capital inflows to make sure that inflationary tendencies remain bridled and the next-year inflation target of 4 per cent remains achievable.
External Sector Developments
The balance of payments position continued to show sustained improvement during July 2002-April 2003 and laid down a solid foundation for the buildup of foreign exchange reserves. The current account of BOP showed surplus for third year in a row and improved by 82.46 per cent to $ 4.6 billion despite deteriorating trade balance.
The improvement resulted primarily from sustained growth in workers’ remittances (expected to exceed $4 billion by the year end), exports earnings (expected to reach the target of $10.3 billion) and enlarged receipts under services account. Workers’ remittances continued to exhibit a rising trend and averaged $354 million a month between July 2002 and April 2003 compared to a monthly average of $187 million in the same period of last year.
Exports registered an impressive growth of 20.8 per cent to $8.8 billion between July 2002 and April 2003 despite the appreciation of rupee against dollar and unstable conditions prevailing in the Middle East. Two major contributory factors to increased exports earnings were relatively more access to the eurozone and US markets, and improved competitiveness of the domestic textile industry. The services account underwent a significant contraction of 34 per cent to $ 1.38 billion exclusively on account of a 52.2 per cent rise in aggregate receipts.
The capital account of BOP also showed improvement because net outflows experienced a contraction of 18.6 per cent to $1.25 billion during July 2002-April 2003 against net outflows in the corresponding period of last year. This resulted exclusively on account of a sharp increase of $0.66 billion in gross inflows emanating from increase in FDI inflows and programme aid from IFIs (non-food receipts).
To sum up, the Pakistan economy is in early stage of its recovery and is expected to do well in view of strong credit demand by the private sector that has resulted from benign interest rate environment and low and stable inflation. Exchange rates are expected to be stable in view of strong performance of the external sector and active presence of SBP in the foreign exchange market. Monetary and fiscal policies are expected to continue to provide enabling environment essential for economic take-off.