What has monetary policy delivered?
On January 31, the State Bank of Pakistan (SBP) further tightened the monetary policy (MP) for January-June, 2008. The MP tightening commenced in July,2005 to control inflation which had reached 9.3 per cent a month earlier.
The main ingredients of the MP are: (a ) 0.5 per cent raise in the policy [discount] rate from 10 to 10.5 per cent (this rate was 9 per cent in July,2005 when the tightening policy commenced) and, (b) increase of one per cent in the Cash Reserve Requirement [CRR) on bank deposits up to one year maturity.
SBP authorities say that the monetary policy can impact the core [non-food/non-energy] inflation only if the government takes supply side administrative steps to control the “food inflation”.
SBP authorities have also been telling the people that a period 12-18 months is required for monetary measures to make an impact. The CPI inflation which was 9.3 by the end FY-05 decelerated to 7.9 per cent by the end of FY-06. The CPI deceleration in FY-06 cannot be attributed to monetary tightening in that year as per the parameters indicated by SBP.
It is, however, strange that the CPI did not decelerate during FY-07 and it stood at 7.8 per cent ( depicting a very marginal change of 10 basis points) at the close of the fiscal. It indicates that monetary tightening did not work.
The situation has become worse in the current fiscal as the CPI has touched 8.8 per cent by December,2008. It is argued that the main factor of rise in overall CPI inflation is the high food inflation put at 12.2 per cent.
As for the core inflation [non-food/non-energy] which, as per SBP, responds to the monetary measures, it was 7.6 per cent in September,2005 and showed decelerating trend in the fiscals FY-06 and FY-07.But after the tightened monetary policy remaining in force for 2 ½ years, it has shot up to 8.7 per cent [year over year]by end December,2008. Thus the CPI and core inflation converged at the same level by the close of first half of the current fiscal. How and why has this happened? Let us examine:
The SBP’s view that the food inflation can be controlled only through supply side measures by the government is half truth. Its reports are replete with assertions that bank loans have been misused by borrowers for hoarding of wheat/ sugar and other food items. Was it not incumbent on the SBP to have initiated measures to stop the misuse, inter-alia, by recalling these loans, putting such loans on high margins or completely banning loans against sensitive food items?
No such effective measure were visible during last eight years. No doubt, in 1986 during the serious sugar crisis, the SBP banned bank advances against sugar and the import of sugar on deferred payment basis by precluding opening of usance letters of credit. These measures remained in force for quite sometime.
Some half-hearted efforts were also made by the SBP viz-a-viz the sugar crisis a few months back and it will be relevant to quote the footnote appearing on page 39 of the SBP report for the quarter July-September,2007:
“With a view to discourage hoarding of sugar and to ensure stability in its prices, SBP on June 9,2006 directed banks to ensure that all advances against the security sugar stock are fully adjusted latest by 31st October, 2006. Further, all renewals / fresh disbursements were made subject to 50 per cent cash margin requirement with the instruction that such advances are made only after a clean up period of at least one month.”
The above policy measures were, however, [promptly] withdrawn on October 27, 2006 [SBP BPRD circulars Nos. 4,10,and 15 of 2006].
Another purpose of monetary policy is to keep the credit/ monetary expansion within specified limits. Keeping in view the projected GDP growth of 7.2 per cent and inflation at 6.5 per cent, the monetary expansion [M-2] during the current fiscal [FY-08] should be 13.7 per cent. However, the annualised monetary expansion for the current fiscal is estimated at much higher level of 19.2 per cent.
The government borrowing from the SBP seems to be the major reason for it because it was asked by the SBP to retire borrowing to the extent of Rs62.3 billion during FY-08 but up to January 19, ,2008, the borrowing from SBP reached Rs237.1 billion. The government borrowed from SBP for retirement of commercial banks’ debt to the tune of Rs3.1 billion. So the SBP’s stock of government Treasury bills have reached Rs624.6 billion.
This has happened despite heavy additional accruals to the government from various domestic sources as follows: (a) higher tax collection--Rs19.4 billion, (b) Pakistan Investment Bonds Rs41 billion and (c) National Savings Scheme Rs26.5 billion. The total (a)+(b)+(c) is at Rs86.9 billion.
Section 9 A (b) of State Bank Pakistan Act,1956, as amended to-date, authorises the board of directors of the bank to determine and enforce, in addition to the overall expansion of liquidity, the limit of credit to be extended by the bank[SBP] to the federal and the provincial governments and other agencies of the Federal government for all purposes, it being understood that the governments will meet their additional credit requirements directly from commercial banks through market based auctioning system to be conducted by the bank [SBP]. In FY-08, just the reverse is happening even though the SBP is cognizant of the fact that the government borrowing from it is highly inflationary.
The question is, why the government is substantially dependant on borrowing from SBP? For the simple reason that these borrowings are virtually cost-free because whatever interest is paid by the government, it reverts back to it, as the SBP profits are transferable to the government.
On whom the responsibility for tall this devolves and why? Obviously on the vulnerability of the SBP before various mafias like wheat, sugar hoarders etc. which have become extra-ordinarily strong during the last decade and because the federal government did not permit institutions to become stronger and play their statutory role in an effective manner.
The net result is that the tightened monetary policy has utterly failed to achieve its designed objectives. It has merely become the tool of increasing lending rates thereby increasing the “cost of business” as is being continuously complained by the business community and enabling banks to make high profits. The lending/ deposit spread is still 7.1 although the efficient banking warrants it to be around 3-3.5 per cent.
The SBP also seems to be vulnerable before the banking community as they do not accept its advice to share their huge profits with the depositors by giving fair returns. One of the reasons is the monopoly of five large banks which together control about 60 per cent of the deposits/ advances. SBP has further encouraged monopolies in the banking sector though mergers and acquisitions.
What will be outcome of the tightened monetary policy in the long run? The closing down of the businesses due to high cost, discouragement to the depositors resulting in containment or fall in savings/GDP ratio (The ratio is already much lower when compared to the neighbouring countries] and business community shifting to the foreign currency loans because of lower cost resulting in partial dollarisation of the economy.
The MP expects the CPI to remain at eight per cent by June,2008. This does not seem possible because government borrowing from SBP is not expected to halt during the rest of the fiscal and depreciation of rupee against dollar (to the extent of 3.7 per cent during July 1,2007- January,19,2008) The rupee may further depreciate by the close of the fiscal, adding to imported inflation and the elected government will have to pass on the impact of increase in international oil prices to the public.
Apart from that, incapability of the SBP/government to stop misuse of bank loans and the lack of effective control over the hoarders will simply add to the bleak side of the picture. These factors will accelerate the inflationary pressures and one should not be surprised if, by the close of the current fiscal, inflation accelerates to over 9-9.5 per cent.
What has monetary policy delivered? -DAWN - Business; February 11, 2008