Monetary policy: a response to fiscal expansion?
State Bank Governor Dr Shamshad Akhtar did not mince words while holding fiscal mismanagement during the first half of current fiscal year responsible for the widening fiscal and external account imbalances, making it imperative to further tighten the monetary policy for the next six months.
She disclosed that the commercial banks and the central bank financed almost 60 per cent of budget deficit from July 07 to January 29, 08 making the job of liquidity management quite challenging.
In the policy announced on February 1, the SBP raised the discount rate by 50 basis points to 10.5 per cent that may push the lending rates of commercial banks to 13 per cent plus. The SBP also enhanced cash reserve ratio (CRR) by 100 basis points for deposits of one-year term to eight per cent. Deposits of more than a year have been spared of CRR to give incentive to banks to offer better rates of return to their depositors.
The risk to inflation outweighs the risk to growth, the Governor said, justifying her policy.
The Governor elaborated that the developments in first half of FY 08 substantially deviated from the monetary framework, says a SBP press release on the Governors more than an hour-long speech on Thursday last. It warns complications for monetary management during the course of the year (07-08) mainly because of the slippages on fiscal deficit targets.
Industry and trade leaders came out immediately with their harsh reactions on monetary policy, warning of a further slow down of businesses and closure of enterprises. Monetary policy is a major cause of slow growth in industrial sector and widening of economic inequalities in last few years, President of the Federation of Pakistan Chambers of Commerce and Industry (FPCCI) Mr Tanvir A Sheikh said in a statement on Friday.
We are inviting State Bank of Pakistan Governor for a meeting with businessmen next week, Sheikh Amjad Rasheed, chairman of the FPCCI Banking and Credit Committee informed Dawn from Nowshera over telephone. He said the tight monetary policy has squeezed business activities beyond tolerance limits. Further monetary tightening will be killing for business, he warned.
Textile export factories are closing down and further tightening of monetary policy is bound to prove the proverbial last straw on camels back Shabbir Ahmad, a leader of value added textile products exporters association said.
In their anger and fury, the industry and trade leaders overlook the government over-spending which seems to be showing no respite. The Governor disclosed that the government borrowed over Rs237 billion so far. Last year in the same period, it borrowed only one-third of this amount. The Governor was sceptical if the government would be in a position to retire Rs63.2 billion loans as projected for 07-08 credit plan.
Where is the law that prohibits government to contain budget deficit to four per cent, asked a trader who is confident that State Bank of Pakistan can invoke this law and put a brake on unlimited government borrowing.
Bankers however defend the monetary policy. A top banker said that the monetary policy is the most appropriate and logical response to the current situation. It is true that inflation is on the rise during the current fiscal year he conceded but argued, Imagine what would have been the impact of a loose monetary policy on inflation. His assessment is that had there been no tight monetary policy, the inflationary pressures would have been three times more than at present.
The banker repeated SBP Governors argument that real interest rate is still very low. Our real interest rate is hardly 4-5 per cent if you adjust the banks mark-up with inflation rate is one standard argument offered by all commercial and central bankers in support of present policies. Financial cost is just a small part of the total production cost is another argument of the bankers.
The financial cost was only three per cent of sale proceeds about five years ago, Shabbir Ahmad retorted and said at present the financial cost is eight per cent of sale proceeds and is hitting the endurance limits.
The governments reliance on banking system for borrowing has led to 19.2 per cent monetary expansion in first half of this fiscal year. Dr Shamshad Akhtars advice to the government is to rein in fiscal slippages in next half of thel year. She also wants the government to mutually agree with State Bank to reduce its stock of papers from Rs624.6 billion to Rs305 billion, an average of last five years. Her advice was for holding jumbo auctions of long-term PIBs, more issuance of sharia-compliance instruments and to generate more inflows into National Savings Scheme. While industry and trade leaders were not in a position to offer any comment on this advice of the SBP Governor, a private banker confided that a plan is being prepared to shift burden of treasury bills and short-term papers to long- term instruments.
No further details of this proposal were available but there are indications of consultations and meetings among the bankers on these issues. The private sector has not been crowded out as business people are trying to convey, a banker said. Private sector credit grew by 10.4 per cent during July 07 to January 19 as against 10.2 per cent growth of the same period last year. Till January 5 this year, the exporters were given Rs139.6 billion as against Rs31.6 billion last year.
Under the Long-Term Financing Facility for export-oriented industries, a sum of Rs8 billion has been allocated for utilisation up to June next. The borrowers have been given option to borrow for three different terms. A three- year loan will carry eight per cent interest, five -year loan nine per cent and 10 -year loan 10 per cent.
How can we think of setting up new factories when our existing plants are being closed because of financial and infrastructure problems, Adil Mahmood, a leader of All Pakistan Textile Association (APTA) said. He wants loans on concession rates for upgrading old plants that will also help in saving on electric and gas consumption.
Financial concessions to textile is said to have caused inflation. Akbar Sheikh, a senior APTMA leader in Lahore attributes this monetary overhang to State Banks wrong money supply policy. How can textile industry be held responsible for this when a slight change in money supply can eliminate this possibility, he asserted. Another textile industrialist recalled that it was high lending that turned the industry sick in the 1990s.
Monetary policy: a response to fiscal expansion? -DAWN - Business; February 04, 2008
