In the last fiscal year, CPI inflation rose 7.8 per cent against the target of 6.5 per cent but food inflation soared to 10.3 per cent.
Government borrowing: The State Bank has advised the government to contain its inflationary borrowings from the central bank by observing quarterly ceilings and by retiring Rs62.3 billion during this fiscal year...
Besides, the SBP has asked the government to finance its budgetary requirements more through long-term financing sources including Pakistan Investment Bonds and less from short- term borrowing from commercial banks. This would raise the cost of domestic borrowing for the government particularly after increase in the discount rate. But it would certainly help fighting inflation as a major chunk of long-term borrowing can be made through non-bank sources which is least inflationary.
It would deepen the secondary market for long-term bonds and provide corporates particularly insurance companies and provident-fund and pension fund managers to park their long-term funds profitably.
Interest rates: In its monetary policy for July-December 2007, the SBP has also raised its discount rate from 9.5 to 10 per cent—the second 50 basis points increase in the rate after July 2006.
The move had an immediate impact on the benchmark six-month KIBOR, which rose 30 basis, points on the first day after the announcement of the policy. It went up from 9.96 per cent to 10.26 per cent. Treasurers of local and foreign banks say it may now remain well above 10 per cent.
The SBP increased the yield on treasury bills as well. It raised the cut-off yield on the benchmark six-month T-bills the very next day after the policy announcement by 20 basis points—from 8.9 per cent to about 9.1 per cent.
Bank treasurers expect the yields on T-bills would rise further as the government would be borrowing more from the commercial banks and less from the SBP.
Business concern: Businessmen are concerned that banks would soon increase their lending rates as a result of the latest tightening of the monetary policy. This would dampen the demand for private sector credit and have an adverse impact on industrial activity.
“This would ruin the industry,” remarked Mr. Tanvir Sheikh, president of the Federation of Pakistan Chambers Of Commerce & Industry.
“It seems that the central bank keeps tightening the monetary policy to let banks make huge profits at the cost of the industry,” he blamed.
Mian Muhammad Latif, chairman of Chenab Group, said that the latest monetary policy would destroy textiles industry beyond repairs.
“The central bank should have realized that textiles and other large-scale industries provide jobs to millions of people and even if some of them are forced to close down it would render thousands jobless.”
He warned that the outcome of frequent tightening of monetary policy would be that, textiles, the largest foreign exchange earner, would loose its competitive edge.
Industrial growth: In the last fiscal year, Pakistan’s industrial sector grew at 6.8 per cent against the target of 9.1 per cent. And within this, the large-scale manufacturing sector grew 8.8 per cent—far below the target of 13 per cent.
A major reason attributed by industry for this slowdown in industrial activity was an increase in the interest rates.. The weighted average lending rate of banks rose from 10.40 per cent in June 2006 to 11.33 per cent in June 2007—a rise of 93 basis points over one year.
A slowdown in the industrial activity took its toll on exports—and exports grew only 3.4 per cent to $17 billion against the target of $18.6 billion. Textile exports grew 5.3 per cent to $10.7 billion. (Bangladesh, a close competitor of Pakistan in exports, posted 16 per cent growth both in its overall exports as well as in textile exports during the same period. Its overall exports rose to $12.2 billion and textile exports totalled $9.2 billion).
Bnakers: President of National Bank of Pakistan Syed Ali Raza dismissed as baseless the perception that interest rates would automatically increase after a 50 basis points increase in the SBP’s discount rate. “We are mature enough to realise that if the interest rates are increased beyond a limit, cash flow of our clients would be hit and that would be detrimental for our business too,” he remarked.
“If industries are burdened with very high interest rates, they would naturally stop servicing bank debts, and banks would have make provisioning against these bad debts. Of course, a banker would not like this situation.”
Besides, Mr. Raza added, banking system is wallowing in excess liquidity; the demand for bank credit is already low and borrowers can now shop around as banks compete fiercely with each other. “All this means that the latest tightening of monetary policy would not necessarily make bank borrowing expensive for a vast majority of our clients,” he said.
“But I assume that 10-20 per cent borrowers may have to borrow at a higher rate now than before but it would be because of their lower credit worthiness.”
Reserve ratio: The central bank has also made some changes in reserve ratios. In January, it had hiked cash reserve requirement from five to seven per cent on demand liabilities of banks but reduced it from five to three per cent on their time liabilities.
Now it has applied a uniform CRR of seven per cent on time-and demand liabilities of less than one-year and exempted all deposits of one- year and longer maturity to help banks raise long-term deposits.
One of the reasons for a very large banking spread is that fixed term deposits account for less than one third of overall deposits. So, an incentive to banks for mobilising long -term deposits would also narrow the gap between lending and deposit rates, which stood at a whopping 735 basis points at the end of the last fiscal year.
Islamic banks: Recognising the shortage of Shariah-compatible papers used by Islamic banks to meet statutory liquidity requirements, the central bank has allowed them to count their cash in hand and balances with the National Bank towards SLR.
No change has been made in SLR of other commercial banks, which remains at 18 per cent of the time and demand liabilities.
This would help the growing Islamic banking industry expand further.
Export Refinance: The SBP has also decided to phase out its subsidised financing to exporters through refinancing scheme. . And as a first step, it would provide export refinance against 70 per cent of the total export financing requirement—and banks would bear the cost of the remaining 30 per cent on their own.
But the move would not impact exporters as such because they would continue to get export finance from banks at a concessional rate of 7.5 per cent. It would, however, helping curbing inflation because the amount that the SBP reimburses to banks under export refinancing, adds to reserve money and fuels inflation.
Stock market: Stock brokers say the hike in SBP’s discount rates and the incentive given to banks to raise long- term deposits would have a negative impact on the stock market. (The Karachi Stock Exchange 100-share index lost 50 points on the first day after the announcement of the new monetary policy).
“I believe the impact of the discount rate hike would be negative on the equity market. The market is rather disappointed with the SBP decision,” commented Mr. Arif Habib, a former chairman of KSE.
But he said that as supply of new bond issues continues to grow, their yields would remain more or less intact. “As KIBOR increases, the issuer would add fewer percentage points over it than before, making no real change in the yield.”