ANALYSIS: No respite in lending rates? —Muhammad Aftab - Monday, February 07, 2011

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The fact is that monetary policy, alone, has failed to reduce inflationary pressure because the high cost of bank finance has actually raised the cost of production and the consumer prices

No respite in lending rates? Rather than a reduction, the inflationary pressures caused by huge budgetary deficits being generated by the government, the fear was that the benchmark discount rate (DR) would go up. Mercifully it did not.

What does it amount to? The central banking has, once again, failed to cut high cost of borrowing and suppress the inflationary spiral. This push has specially raised food prices and stunted the demand for industrial products and services.

The State Bank of Pakistan (SBP) Governor Shahid Hafeez Kardar while announcing retaining the benchmark discount rate or the policy rate at 14 percent offered a rationale, which has not worked over the last three years when the Tight Monetary Policy (TMP) was first introduced. He said, “The SBP is aware of the delicate balance that needs to be struck between risks to inflation and economic growth. It, therefore, has decided to keep the DR unchanged at 14percent for the time being.” The government should spell out “a clear and coherent strategy to limit fiscal slippages,” he also said.

Pause for a minute! The fact is that monetary policy, alone, has failed to reduce inflationary pressure because the high cost of bank finance has actually raised the cost of production and the consumer prices. There is hardly any supply-side step taken by the government to remedy the situation.

Mr Kardar must realise something more. The TMP that will continue until the end of March also admits its failure to check rising inflation, stemming from the record high government borrowing from the SBP and commercial banks to reduce the budget deficit.

While the SBP maintained its DR or policy rate at 14 percent for the next two months, businesses and the industry are clamouring for a reduction by at least two percent that could bring commercial banks’ lending rate for small borrowers that has risen to 18 percent. In fact, the commercial banks’ lending rate may move still higher as the SBP has asked the government to shift its borrowing from the SBP to commercial banks. It has asked the government to restrict its borrowing from the central bank to below the end-September stock of Rs 1,290 billion.

The dark cloud of the outstanding stock on cash basis had risen from Rs 1,171 billion in mid-June 2010 to Rs 1,500 by mid-December 2010 but had closed at Rs 1,277 billion as of January 25, 2011. This stock or the monetary hang is escalating inflation, which year over year (YOY) was 15.66 in January but is forecast to rise further. Independent economists feel that if drastic measures are not taken to end government borrowing from the SBP and reduce the stock of debt, coupled with rising prices of imported food and oil, inflation can shoot much higher.

Islamabad somewhat shifted its borrowing from the SBP and borrowed Rs 200 billion from commercial banks. It impacted their liquidity, reduced advances to the private sector and raised interest rates. Banks are now charging 16 to 18 percent.

As of now, and for the last three years of the PPP government, the rising cost of doing business, higher interest rates and massive power outages have translated into a reduced domestic demand from consumers who are left with reduced purchasing power and this has drastically impacted business. Large-scale manufacturing sector (LSM), alone, for instance, reported a 2.3 percent decline in growth during July-November — the first five months of current FY-2011. “The fundamental problem hampering the economy is a lack of liquidity. Lending rates will go on rising until the government access to the liquidity pool is cut off,” monetary policy analysts stress.

What is wanted? It calls for drastically narrowing down the government’s fiscal deficit, which has ballooned because of sheer waste and corruption in government spending, rising cost of the ongoing war on terror and outright theft of nearly 35 percent of all electricity generated by the government-owned hydel and thermal plants. In view of such wasteful spending, the opposition political parties and provincial governments have refused to levy an IMF-proposed VAT and other taxes because that will enlarge the drain.

The cut in the debt stock of government borrowing as on January 25 is described by the SBP as “encouraging”, “a trend if sustained can help in restricting excess money growth and moderating expectations of high inflation.” The external current account showed a surplus of $ 26 million during the first half of FY-2011, which is “a marked improvement over earlier expectations. Robust export earnings of $ 11.1 billion in the first half of the year are the chief reason leading to this development. Higher exports and a positive external account were helped by higher export prices of textiles and rice.”

Luckily, still more support to the external current account during the first half-year was provided by “strong inflows of home remittances” sent by overseas Pakistanis, including those working in the UAE, Gulf, Saudi Arabia, the US and the UK. The remittances totalled $ 5.3 billion. The inflow of $ 743 million Coalition Support Funds (CSF), which partly reimburses Pakistani spending in the war against terror and “a modest foreign direct and portfolio investment” also helped the SBP’s forex reserves, which rose from $ 13 billion at end-June 2010 to $ 13.5 billion at end-December 2010.

“This build up in reserves and net foreign assets (NFA) is one of the factors responsible for stability in the financial markets. This is despite the increased borrowings from commercial banks by both the government and the private sector, especially in the second quarter — October to December — of FY-2011. But even a small external current account deficit in FY-2011 can pose challenges for an adequate build up of foreign exchange reserves,” the SBP cautions. So here lie the prospects and problems for Pakistan’s foreign trading partners. But hope continues kindling.

The writer is an Islamabad-based journalist and former Director General of APP

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