When the electronic media approached her, enquiring about the economic problems facing the country, she focused on tackling the inflation which had by then reached 9.3 per cent (average).
During over 2 ½ years as SBP governor, she has continued to tighten the monetary policy, raising the policy rate and changing the Cash Reserve Ratio [CRR] and Statutory Liquidity Requirement Ratio [SLR] from time to time. About half a dozen monetary policy statements were issued and the policy rate was enhanced on five different occasions: July 29, 2006 (9.5 per cent); August 1, 2007 (10 per cent); January 31, 2008 (10.5per cent); May 23, 2008 (12 per cent) and July 30 ,2008 (13 per cent).
The purpose of this write-up is to examine whether the policy measures taken by the SBP have achieved the desired objective and if not, what are the reasons of failure and whether the continuation of the failed policy will serve any purpose in future.
The CPI inflation averaged by the end of the fiscal 2005 was 9.3 per cent , which decelerated to 7.9 per cent by the close of the fiscal FY-06 and to 7.8 per cent at the close of FY-07. The drop in the inflation during FY-06 cannot be attributed to the SBP policies since the beginning of the calendar year 2006 as the SBP authorities tell us that outcome of the policy measures become be visible only after a lapse of 12 or more months.
The position become precarious in the FY-08 during which CPI inflation (average) rose to 12 per cent. If we look at year-over-year (YoY) CPI inflation for the month of June,2008, it reached 21.5 per cent- the highest in the country’s history-- while YoY food inflation during June,2008 rose to 32 per cent. This is clearly indicative of the fact that the economy is not responding to the SBP policy measures.
Inflation was much higher than the target for FY-07 and FY-08 fixed at the beginning of the year. If the sharp acceleration in inflation was not controlled during FY-09, the 12 per cent target fixed for the current fiscal will not be achieved.
The food inflation contributed 62.04 per cent to the CPI during FY-08. According to the SBP authorities, food inflation can be controlled only through the supply side measures. Then what has been left for the monetary policy measures?
The tightening of monetary policy aims at containing/reducing money supply, thereby reducing demand pressure. There are, however, some matters relating to the monetary (M-2) expansion which are beyond the “de-facto” yet under “de-jure” jurisdiction via Section 9(A} of State Bank of Pakistan Act as amended to-date to make the SBP “ autonomous.”
Under this “autonomy”, the SBP board of directors can fix the limits up to which federal and provincial governments can borrow from the SBP and if further resources are required, SBP can ask the government to borrow from commercial banks. The “authorities that be” at the federal level are so powerful that SBP in not in a position to exercise its legal jurisdiction with the result that borrowings by the federal government from SBP are rampant and in FY-08, the same stood at Rs688.7 billion. SBP advised the government to retire SBP debt at Rs21 billion per quarter in the current fiscal; but the response has been borrowings of Rs32.9 billion during the first 25 days of the fiscal.
The government is borrowing from SBP even for retirement of commercial banks’ debts and the monetary policy for July-December,2008 [MP] puts the amount at Rs134.2 billion in FY-08. This has not happened for the first time. During the tenure of previous SBP governor too, commercial banks’ debts were retired by the government by borrowing from the SBP whose status is no more than a subservient department of the ministry of finance.
The government borrowing from SBP is virtually cost-free because SBP profit is eventually transferred to the government as confirmed by the SBP. This process also enables the government to understate the quantum of fiscal deficit as it reduces the expenditure.
The economy has not reached a stage where it could respond to the policy measures and the authorities could leave every thing to the mercy of the “market”. Strict regulatory measures are the demand of the times to discipline the “market”. In view of the constraints, SBP is left with the only option of falling back upon the private sector for achieving the monetary management objectives.
Some tough measures were announced on the May 23,2008 by the SBP to curb demand pressures with specific reference to “imports” expecting some relief on the “current account” which, inter-alia, included: reducing the limit of advance payments against imports [through letters of credit] to 25 per cent, suspension of forward cover on imports etc. Earlier, imports were put at 35 per cent margin with the exception of food items and industrial raw material.
These measures are essentially the regulatory ones. A day before the announcement of the monetary policy, SBP governor had warned the banks that the Karachi inter-bank offered rate [KIBOR], which forms the bench-mark for determining the lending rates by banks for their customers, should not exceed 13-13.5 per cent. What should we call this directive? Obviously, a regulatory measure as the monetary policy itself was not expected to respond to the policy measures.
The measures recently announced by the SBP require the banks to pay interest on PLS savings accounts at least at five per cent per .annum. This is also a regulatory measure taken belatedly on public pressure as banks did not listen to the SBP governor’s advice despite unprecedented increase in their profits year-over-year. The cumulative profit of banks rose from Rs7 billion in 1997 to over Rs123 billion in 2006, the lending-deposit spread being very high; the July-December, 2008 monetary policy puts it at 6.77 per cent against the international norm of 3-3.5 per cent..
Keeping in view the current inflation scenario, SBP should further regulate the deposit rates structure so as to bring it to a minimum 7-7.5 per cent. This will still leave a very wide margin for banks.
The SBP claims that it has moved away from “regulated” to “market-oriented” banking. This is at best a half truth. We are still providing export refinance/ long-term loans for machinery procurement by the export sector industries and concessional loans for spinning sector etc.
However regulatory measures, whenever or wherever required, should be taken without delay. For instance, the demand pressures, vis-a-vis the external sector, were visible in FY-07 when the current account deficit rose to $6.9 billion. The measures with respect to imports e.g. reduction in the volume of advance payments/ margin requirements etc should have been taken during FY-07 or soon after close of that fiscal instead of waiting for one more year, if the SBP authorities felt that this will put sizable dent on import bill. Whether these measures will bring any significant reduction in foreign exchange spending on imports is, however, debatable.
The point to ponder upon is, when government’s rampant borrowing from the SBP is nullifying the impact of latter’s monetary policy measures, what is the rationale for raising the interest [lending] rates for private sector adding to the “cost of doing business” (and consequently the inflation); howsoever nominal impact, in the SBP’s analysis, it may have.