The SBP has been managing the monetary and exchange rate policies extremely well during the last two financial years. The annual inflation rate averaged about four per cent and the Rupee-dollar parity was maintained at around 5 per cent to a dollar. Both these macroeconomic indicators were achieved with lowest rates of public and private borrowing in the history of Pakistan. Suddenly both these vital macroeconomic indicators became highly apprehensive.
The picture became blurred since, the beginning of the current fiscal year especially in the July-September quarter. The big alarm signal came from the sudden burst of inflation, The inflation rate in October 04 as compared with October 03 was over nine per cent and the Sensitive Price Index (SPI), which is an inflation indicator for poor households jumped to 14 per cent. The economic policy makers all over the world dread double-digit inflation.
Inflation at such a high rate inflicts an unbearable pain on wage earners and rewards as-set owners, thereby increasing income disparities and maldistribution of income. it aggravates poverty in a country where one-third of the household are already living below the poverty line, Inflation normally does not spike in the manner in which it has in July-October 04. The money supply as well as production of goods and services impact on inflation.
The State Bank was ignoring the increase in currency in circulation as well as the accumulation of Net Domestic Asset, during the last fiscal year (FY 04). The currency in circulation has increased by 16.9 percent as compared to 14 percent a year earlier. If the currency in circulation had increased by only 10 to 12 per cent the rate of inflation could have been contained.
The other monetary aggregate, which was allowed to slip, is the Net Domestic Asset (NDA), which increased by 23.7 percent in FY 04 as compared it) less than one percent increase in the previous year. Hence, there is no doubt that there was a monetary overhang at the beginning of the current fiscal year, which has propelled the increase in prices. The State Bank also failed to curb the private sector credit in the current financial year.
The private sector credit of Rs.64 billion disbursed during the period July to October 04 is more than double the figure of Rs 3 1.8 billion for the same period of last year. The Governor of the State Bank warned the hankers against "reckless lending or optimistic forecasting that current low interest rate environment would remain unchanged in the future is bound to get your institutions into deep trouble". Yet he did not Use any policy instrument like raising the interest rate, cash requirement for banks or cash credit ratio. He has allowed the privatized banks and others to indulge in this "reckless lending".
On the supply side causing 15 per cent increase in food items, is the sharp rise in the price of wheat. After harvesting 21 million tonnes in Rabi 2000, production during the last four year-s has stagnated around 19 million tones (Target for Rabi 2005 is 20.2 million tonnes). The overall increase. in agricultural output, which supplies food items was only 2.5 per cent. The government has increased the support price of wheat by 33 ) per cent in last two years. Such a sharp rise in staple commodity is bound to lead to a double-digit inflation.
The Rupee-dollar parity has declined by about 5 per cent since July 0 1, 2004, There are two foreign exchange markets in Pakistan. The first is Inter-Bank rate and the other is the Open market rate. The bank rate is fed by exports and remittances and drained by imports and invisible payments.
The open market rate, which is the rate for changing currency notes, is fed by dollars from Afghanistan drug trade and foreign currency sold by non- resident Pakistani visitors, The demand for foreign currency notes is from Pakistanis travelling abroad as well as those remitting foreign currency to countries where they expect a better return, It has been reported that large number of Pakistanis has taken brief cases laden with dollars for real state investment in Dubai.
The two foreign currency markets however move in tandem and the diversion between them has never been more than one rupee.
The exports during the July-September quarter have increased by 17 per cent but imports have increased by .18 percent. The trade imbalance, which. was S145 million in July-September 04, has deteriorated to $ 839 million in July-Sep 05. The remittances have increased by 8.5 percent in July-Sep 05.
The foreign exchange reserves at end September 04 were above 12 billion, however there was a dramatic change in the composition of reserves. Whereas the reserves held by the SBP have declined by $5833 million, the reserve of the banking system, which includes foreign currency account-, have risen by $560 million.
The SBP has intervened in the market without success and there has been a lack of coordination with. the banks, which has resulted in Rupee sliding by 5.5 per cent in four months, This slide should have been. prevented for number of reasons. The 'State Bank should have allowed the reserves to deplete, by up to dollar one billion to preserve the parity below sixty.
Firstly, such a rapid depreciation of rupee will stoke the fires of inflation whose flames are all around. Stability of Rupee-dollar parity is essential to contain inflation. Secondly, a sharp depreciation leads to one-way speculation. Rupee will come under greater Pressure as everybody is expecting it to decline further. In fact. the State Bank should have increased ? the cash margin for opening LC's from 20 to 30 per cent in order to avoid speculative imports.
Pakistan has dollar denominated debt of $ 33 billion., Hence a slide in dollar parity of Rs3 increases the rupee burden of foreign debt by Rs.99 billion.
The government has very wisely decided to absorb the increase in international price of oil, If the increase in international price had been passed on to the consumers in Pakistan, the inflation rate would have gone beyond 15 percent. However, there is a fiscal cost to this absorption,
The receipts from Petroleum Development Surcharge (PDS) will fall sharply, If the rupee depreciates the fiscal burden of protecting Pakistanis consumers from the spike in the prices of oil in the international market will spur accordingly.
Exchange parity has psychological and economic dimensions. The author travelled to India in mid 1980s and exchanged 80 Pak rupees. for 100 Indian rupees. Now one will not get 80 Indian rupees for 100 Pak rupees. In a way this is a measure of economic mismanagement in 1990s. The Indian rupee-dollar parity is 46 to 47, The Bangladesh Taka-dollar parity is 58.
The Pakistani rupee dollar parity is Rs.61, Most people who do not understand the working of exchange parity will rightly assume that Pakistani economy is doing worse than Bangladesh and much worse than that of India. We Takka-dollar Parity.
The fixed dollar expenditures on repayment of foreign loans, foreign missions and defence equipment which is imported, will increase budget deficit.
Reserves by definition are meant to used when needed. The spurt in import bill caused by 60 percent rise in international price of oil and other factors needs to be absorbed by fall in reserves. The Pak rupee ought to be defended from sliding so rapidly and the State Batik must use all policy instrument at its command to bring the rupee-dollar parity below Rs.60 again.
The author is former Secretary, Planning, Government of Pakistan.